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Asset Restructuring and the Cost of Capital

Ranjan D'Mello, Sudha Krishnaswami and Patrick Larkin
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Ranjan D'Mello: Wayne State University
Sudha Krishnaswami: University of New Orleans
Patrick Larkin: Fayetteville State University

No 2005-14, Working Papers from University of New Orleans, Department of Economics and Finance

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.

Keywords: Spinoff; Cost of equity; Information asymmetry (search for similar items in EconPapers)
JEL-codes: G34 C22 C12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-fmk
Date: 2005
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