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Asset Restructuring and the Cost of Capital

Author

Listed:
  • D'Mello, Ranjan

    (Wayne State University)

  • Krishnaswami, Sudha

    (University of New Orleans)

  • Larkin, Patrick J.

    (Fayetteville State University)

Abstract

We empirically examine whether the elimination of negative synergies, the reduction of internal capital market inefficiencies, and the mitigation of information problems following spinoffs lower cost of equity. The results indicate that there is no decrease in the cost of equity in the full sample, which suggests that the gains around spinoffs are primarily a consequence of improvements in cash flow and operating performance rather than a decline in systematic risk or the cost of equity. However, we find a positive relation between the spinoff gains and a decrease in the cost of equity for the subsample of firms with high information asymmetry, and for the subsample of non-focus-increasing spinoffs shown in prior studies to have no improvements in future cash flow or operating performance. For firms with high information asymmetry, the relation between the spinoff gains and the decline in cost of equity is attributable to a decline in the cost of equity of the post-spinoff parent entity. The results indicate that spinoffs facilitate a decrease in adverse selection costs, and this is especially value enhancing for the parent firms, which are higher growth and more reliant on external capital.

Suggested Citation

  • D'Mello, Ranjan & Krishnaswami, Sudha & Larkin, Patrick J., 2005. "Asset Restructuring and the Cost of Capital," Working Papers 2005-14, University of New Orleans, Department of Economics and Finance.
  • Handle: RePEc:uno:wpaper:2005-14
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    Keywords

    Spinoff; Cost of equity; Information asymmetry;

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General

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