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The Design of Financial Policies in Corporate Spin-offs

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  • Vikas Mehrotra

Abstract

We examine differences in financial leverage between parent and spun-off firms that emerge from corporate spin-offs. Our tests control for past financing choices and the costs of adjusting capital structure, factors that can obscure cross-sectional patterns among firms' target leverage ratios. We find that firms that emerge from spin-offs with more financial leverage have a higher cash flow return on assets, lower variability of industry operating income, and a greater proportion of fixed assets. The positive relation between profitability and the use of financial leverage, in a setting that is free of pecking order effects, is particularly important because it contrasts with existing evidence. Our results indicate that the ability to cover debt payments and default-related costs are important determinants of the use of financial leverage, as implied by the trade-off theory of capital structure. We find no evidence that managerial incentives or governance characteristics affect the difference in leverage ratios in firms that emerge from spin-offs. Copyright 2003, Oxford University Press.

Suggested Citation

  • Vikas Mehrotra, 2003. "The Design of Financial Policies in Corporate Spin-offs," Review of Financial Studies, Society for Financial Studies, vol. 16(4), pages 1359-1388.
  • Handle: RePEc:oup:rfinst:v:16:y:2003:i:4:p:1359-1388
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    File URL: http://hdl.handle.net/10.1093/rfs/hhg027
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    Cited by:

    1. Vithessonthi, Chaiporn & Tongurai, Jittima, 2015. "The effect of firm size on the leverage–performance relationship during the financial crisis of 2007–2009," Journal of Multinational Financial Management, Elsevier, vol. 29(C), pages 1-29.
    2. Riccetti, Luca & Russo, Alberto & Gallegati, Mauro, 2013. "Leveraged network-based financial accelerator," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1626-1640.
    3. Luca Riccetti & Alberto Russo & Mauro Gallegati, 2015. "An agent based decentralized matching macroeconomic model," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 10(2), pages 305-332, October.
    4. Madura, Jeff & Ngo, Thanh & Viale, Ariel M., 2012. "Why do merger premiums vary across industries and over time?," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(1), pages 49-62.
    5. repec:eee:corfin:v:45:y:2017:i:c:p:1-18 is not listed on IDEAS
    6. McMillan, David G. & Camara, Omar, 2012. "Dynamic capital structure adjustment: US MNCs & DCs," Journal of Multinational Financial Management, Elsevier, vol. 22(5), pages 278-301.
    7. Cronqvist, Henrik & Low, Angie & Nilsson, Mattias, 2007. "Does Corporate Culture Matter for Firm Policies?," Working Paper Series 2007-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics.

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