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Change in Parent’s Cost of Equity Capital around Equity Carve-Out
Tam, Lewis H.K.
Source PublicationCorporate Ownership & Control

Equity carve-out transactions typically result in greater disclosure and more analysts following. Does this change in information environment affect the parent firm’s cost of capital? Having a sample of 142 equity carve-out transactions completed between 1982 and 1997, I examine this question by estimating their cost of equity with a residual income model. The results show that the average cost of equity of parent firms declines by about 64 basis points after carve-outs, after controlling for changes in financial leverage and risk-free rate. This decline in the cost of equity is greater for multi-divisional firms. Equity carve-outs that create pure-plays result in a larger decline in the cost of equity. Furthermore, the greater the increase in analyst following, the larger is the decline in the cost of equity around carve-outs. Overall these results imply that reduction in information asymmetry surrounding equity carve-outs is a key reason for the decline in cost of external financing. The major contribution of this paper is to show that it is the decline in the cost of equity, rather than an expected improvement in future earnings, that generates value for parent firms in equity carve-out transactions.

KeywordEquity Carve-outs Corporate Restructuring Residual Income Model Unlevered Excess Cost Of Equity
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Document TypeJournal article
CollectionFaculty of Business Administration
AffiliationDepartment of Finance and Business Economics, Faculty of Business Administration, Room PLG410, Pearl Jubilee Building, University of Macau, Taipa, Macau
First Author AffilicationFaculty of Business Administration
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GB/T 7714
Tam, Lewis H.K.. Change in Parent’s Cost of Equity Capital around Equity Carve-Out[J]. Corporate Ownership & Control,2011,9(1):441-454.
APA Tam, Lewis H.K..(2011).Change in Parent’s Cost of Equity Capital around Equity Carve-Out.Corporate Ownership & Control,9(1),441-454.
MLA Tam, Lewis H.K.."Change in Parent’s Cost of Equity Capital around Equity Carve-Out".Corporate Ownership & Control 9.1(2011):441-454.
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