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Do Spin-offs Expropriate Wealth from Bondholders?

Listed author(s):
  • William F. Maxwell

    (University of Arizona.)

  • Ramesh P. Rao

    (Oklahoma State University.)

A wealth transfer from bondholders to stockholders is one of several hypotheses used to explain stockholder gains on the announcement of a spin-off. However, previous empirical research has not found systematic evidence supporting the wealth expropriation hypothesis. Using a larger sample with comprehensive bond data, we find evidence consistent with wealth expropriation. Bondholders, on average, suffer a significant negative abnormal return during the month of the spin-off announcement. However, even accounting for the loss to the bondholders, the aggregate value of the publicly traded debt and equity increases on a spin-off announcement, suggesting that the wealth expropriation hypothesis is not a complete explanation of the stockholder gains. In explaining the magnitude of the losses to bondholders, we find they are a function of the loss in collateral in the spun-off subsidiary and the level of financial risk of the parent firm. Consistent with a loss to bondholders, firms are more likely to have their credit rating downgraded than upgraded after a spin-off. Additionally, consistent with the wealth transfer hypothesis, losses to bondholders tend to be more severe, the larger the gains to shareholders. Copyright (c) 2003 by the American Finance Association.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 58 (2003)
Issue (Month): 5 (October)
Pages: 2087-2108

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Handle: RePEc:bla:jfinan:v:58:y:2003:i:5:p:2087-2108
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