Do Spin-offs Expropriate Wealth from Bondholders?

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.