Corporate restructuring system and corporate value in Japan

Hiroshi Onuma
School of Management
Tokyo University of Science
500 Shimokiyoku, Kuki-city, Saitama 346-8512
onuma@ms.kuki.tus.ac.jp
July 2007

* I appreciate the thoughtful comments by Doug Shackelford, Ed Maydew, and some members attending the free
topics workshop held as part of a national conference of the Tax Accounting Research Association 2006. All errors in
this paper are solely my responsibility.

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Corporate restructuring system and corporate value

Abstract
This paper addresses two questions related to corporate restructuring. First, do market participants react to
corporate divestiture announcements? Second, when managers conceive a restructuring plan, what of
divestiture methods do they employ in their corporate restructuring? To answer these questions, I
composed a useful event study model to measure abnormal returns and attempted to identify the responses
of market participants. Using this model, I found a positive reaction to corporate restructuring
announcements from both the acquired firms and the target firms. Moreover, using an ordered logit
regression model, I have attempted to elicit from my research sample an affirmative result on the method
choice. The results provide weak evidence that managers choice of a restructuring method depends on the
consideration of certain assumptions.

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Corporate restructuring system and corporate value

Introduction
The purpose of this paper is to investigate whether the law and tax systems for corporate restructuring influence

corporate value in Japan. Further, this paper aims to identify the economic factors that affect the choice of the
divestiture method for restructuring. In this research, I assume that managers maximize shareholder wealth in their
divestiture decisions, taking the decision to divest as given. Moreover, organization restructuring decisions reflect
the indicators of corporate financial data and financial data itself. This assumption is consistent with the outcome of
discussions with investment bankers, consultants, and accountants, who indicate that such important decisions
usually concern various other management decisions.
This paper focuses on the restructuring between groups. On collecting financial data and information from
sample firms that carried out organization restructuring, I became aware of an interesting fact. There are two modes
of corporate restructuring. One is restructuring within corporate groups, and the other is restructuring between
corporate groups, which is the main issue in this paper. I have mainly two reasons for concentrating on the latter type
of corporate restructuring.
First, I have a keen interest in the managerial motive for seeking resources outside the organization. In
general, when the management wishes to carry out a series of corporate reconfigurations, I assume it will attempt to
activate idle resources within the organization. On the other hand, it is natural for the management to contemplate a
fusion between the resources within and outside the organization and pursue operating and financial synergies. This
is my question how I can get through some indication from the corporate financial data when I consider from the
latter view.
Second, I am interested in market participants reactions to divestiture announcements. In particular, when
divisions of a firm combine with the departments of other corporate groups, do market participants perceive this as a
good event or a bad one? If a firm attempts restructuring using the managerial resources of another corporate group,
in general, both groups share the stocks of the newly established company. Therefore, even though the newly
established company is separate from the original corporate groups, a certain capital relationship remains between
the groups. Nonetheless, the information buried in the two corporate groups still spills over into the market when
they implement corporate restructuring. This paper empirically analyzes the information hypothesis that corporate
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restructuring, including divestiture and M&A, enhances value because it mitigates the information asymmetry in the
market about the profitability and operating efficiency of the different divisions of the firms undergoing restructuring.
Consistent with this proposition of the information hypothesis, I find that firms that separate their organizational
divisions have lower abnormal returns than firms that incorporate the divisions into the organization.
This research contributes to the growing body of literature examining divisive corporate restructuring all over
the world; Baldwin and Bhattacharyya (1991), Slovin, et al. (1995), Kaiser and Stouraitis (1995), Lang, et al. (1995),
Parrino (1997), Erickson (1998), Maydew, et al. (1999), Krishnaswami and Subramaniam (1999), Krishnaswami, et
al. (1999), Erickson and Wang (2000), Ayers, Lefanowicz, and Robinson (2000), Weaver (2000), Henning and Shaw
(2000), Henning, Shaw, and Stock (2000), Clubb and Stouraitis (2002), and Scholes, et al. (2005) have investigated
why and how firms divest and how the market in general responds to divestiture decisions.
Krishnaswami and Subramaniam (1999) empirically examine the relationship between information asymmetry
and corporate value in corporations. They analyze the information hypothesis and find that firms that engage in
corporate restructuring have higher levels of information asymmetry than their industry- and size-matched
counterparts and that the information problems decrease significantly after corporate restructuring. In addition, they
endeavor to investigate the market reaction and find that abnormal returns around the dates of corporate
restructuring announcements are positively related to the degree of information asymmetry and that this relation is
more obvious in the case of firms with fewer negative synergies between divisions. Ultimately, firms with higher
growth opportunities and those in need of external capital show a higher propensity to engage in corporate
restructuring.
Maydew, et al. (1999) examine the extent to which taxes influence the choice of the divestiture method, which
could be either tax-free corporate restructuring or a taxable sale. They find that the tax costs are substantial,
averaging 8% of the market value of the divested assets, and that cross-sectional deviations in tax costs have a large
impact on managers choice of a divestiture method. Their results are consistent with two explanations. First,
managers are willing to incur avoidable tax costs to gain earnings and cash flow benefits. Second, managers prefer
the taxable sale option because the acquisition premium on the sale exceeds the avoidable tax cost.
Frank and Harden (2001) investigate corporate restructuring and divisive corporate restructurings in which a
firm makes a subsidiary public. By comparing equity carve-out with corporate restructuring, they examine which
characteristics affect the choice between these alternatives. They find that cash constraints, marginal tax rates,
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subsidiary profitability, and the growth potential of the subsidiarys industry are significant factors associated with
the choice of the divestiture method. Firms that opt for equity carve-out are more likely to be cash constrained and
have lower marginal tax rates. In addition, the subsidiaries of such firms are more likely to belong to higher-growth
industries and are more profitable than corporate restructuring subsidiaries, implying that the market demand for
shares may be factored into the divestiture decision. Further, parent firms are more likely to carve-out subsidiaries in
related industries, suggesting that tangible or intangible synergies with the subsidiary may affect the divestiture
structure.
In this study, I examine 61 cases on corporate restructuring. In particular, this research focuses on the
restructuring between corporate groups. In the market analysis, I found that the market reacts to corporate
restructuring announcements positively, but this response is temporary. Without exception, the initial reactions of
both the acquirer and target firms are positive and significant, but 5 days after the announcement, the result tends
toward insignificance. Next, this paper examines what motivates managers to attempt to restrict their organization
using various methods. Based on an ordered logit regression model, I analyze the methods that managers select and
the factors they focus and rely on. As a result, I find that firms that carry out restructuring between corporate groups
initially intend to establish a new company in cooperation with other firms and seek a different restructuring method.
The paper proceeds as follows. The next section describes the tax aspects of several corporate divestiture methods
exclusive to the Japanese law system. Section 3 develops a hypothesis about market analysis. Section 4 describes the
sample of this research and reports the empirical methodology and result of the market analysis. Then, Section 5
proposes the hypotheses and discusses the results of a logit model used to analyze the relative importance of the
various decision criteria in choosing a divestiture method. Finally, Section 6 provides suggestions for future
research.

Structural analysis of corporate restructuring in Japan

2.1

Various types of corporate restructuring schemes in Japans corporate law

The new corporate divestiture system, introduced in 2001, refashioned the old system by classifying corporate
divestitures into four types. Corporate divestiture means that the divesting parent takes over the target organization.
Before proceeding to the research design topics, I will briefly describe the Japanese law system pertaining to
accounting and taxation.
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Company law governs all business practices in Japan. The other laws, such as the Securities and Exchange Law and
corporate tax law, hold a subordinate position to Japanese company law (JCL). JCL was amended to Japanese
commercial law and enacted in 2006. JCL defines corporate divestiture as the separation of business departments; it
does not assume the separation of subsidiaries. The term divestiture is based on the sellers viewpoint. From the
target firms viewpoint, the same event is referred to as a combination in the sense that existing businesses are
combined and transformed into another business.
When the target is an existing company, we refer to this type of divestiture as kyuushuu-bunkatsu, or absorbed
divestiture (AD). On the other hand, when the target is a new company, we refer to this type of divestiture as
shinsetsu-bunkatsu, or newly formed divestiture (NFD). In corporate divestitures, the target firm issues the stocks in
consideration of the transfer of the organization.
When these stocks are allotted to the divesting parent, we refer to this type of divestiture as butteki-bunkatu or
bunshagata-bunkatsu, which is similar to a spin-off or subsidiary sale. When these stocks are allotted to the
shareholders of the divesting parent, we refer to this type of divestiture as jinteki-bunkatu or bunkatsugata-bunkatsu,
which is similar to a split-off or a spin-off.
The JCL classification has only four types of divestitures. The first type is called newly formed asset sold
divestiture (we refer to this as shinsetsu-butteki-bunkatsu). In this type of divestiture, the target issues the stocks as
the proceeds of a transfer of the organization, and these stocks are allotted to the divesting parent. This type of
divestiture is similar to subsidiary sales and asset sales. The second type of divestiture is called newly formed
spin-off divestiture (we refer to this as shinsetu-jinteki-bunkatsu). In this type of divestiture, the target issues stocks
as the proceeds of a transfer of the organization, and these stocks are allotted to the shareholders of the divesting
parent company. This type of divestiture is similar to a spin-off.
The third type of divestiture is called absorbed asset sold divestiture (we refer to this as
kyushu-butteki-bunkatsu). This type of divestiture is actually the same as an asset sale to the other corporation. After
the department or division is sold to another company, the target allots its stocks to the original company as proceeds.
The fourth type of divestiture is called absorbed spin-off divestiture (we refer to this as kyushu-jinteki-bunkatsu).
After the department or division is sold to another company, the target allots its issued stocks to the shareholders of
the original company, that is, the divesting parent, as proceeds.
The entire structure of the new Japanese divestiture system is shown in Figure 1.
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(Insert Figure 1 here.)

There are other types of restructuring pertaining to the creation of a cooperative organization. On this scheme, we
have several types of divestiture. One is cooperative newly formed spin-off divestiture, and the other is cooperative
absorbed divestiture. Cooperative newly formed spin-off divestiture means that two or more firms establish a new
company collaboratively and transfer management resources and risks to this new company.
(Insert Figures 2 and 3 here.)
Among other types of organization restructuring, there are two forms of reorganization: (1) stock transfer and
(2) stock-for-stock merger. Stock transfer is a method of founding a new holding company in which the original
companies transfer their outstanding shares in the securities market. Stock-for-stock merger is another method of
transforming a company into a wholly owned subsidiary.
(Insert Figure 4 here.)

2.2 Overview of the tax system for corporate restructuring

In 2002, we renewed our taxation system pertaining to corporate restructuring. The rules of corporate tax law
governing division divestiture were amended to devise the new system for corporate restructuring, including
tax-qualified divestiture, merger, and so on.
Corporate tax law is applicable only for divestitures resulting in newly formed companies. The thoughts
underlying these rules are different in Japanese corporate law and the US-IRC, which rests on the consolidated
financial accounting perspective. According to corporate tax law in Japan, there are two types of divestiture:
tax-qualified divestiture, or tax-free divestiture, and tax-disqualified divestiture, or taxable divestiture.
Those opting for tax-qualified divestiture need to meet certain requirements (2.12-11, Reg. 4-2.46). I will
briefly introduce these rules. Basically, the divesting parent owns 100% shares of the target firm. However, if the
divesting parent owns over 50% but less than 100% of the targets shares, the parent firm can enjoy the benefit of
tax-disqualified divestiture as long as it satisfies the following conditions.
z

The target takes over from the divesting parent the main assets and liabilities that constitute the transferred
business.

The target takes over 80% of the employees who work for the transferred business.

The target operates the business that is transferred from the divesting parent.
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In case the divesting parent and target opt for a cooperative newly formed spin-off divestiture, the parent firm can
enjoy the benefit of tax-disqualified divestiture as long as it meets the following conditions:
z

The target continues to hold the stocks distributed from the divesting parent on the date of divestiture.

The target takes over from the divesting parent the main assets and liabilities that constitute the transferred
business.

The target takes over 80% of the employees who work for the transferred business.

The target operates the business that is transferred from the divesting parent.
The cost of divestiture can be reduced by satisfying the abovementioned conditions. Therefore, it is presumed

that the new company law and taxation rules for divestiture encourage corporate restructuring.

Hypothesis development
According to Krishnaswami and Subramaniam (1999), the potential sources of gains from corporate

restructuring, including spin-offs and M&A, analyzed in these studies may be classified as follows: (i) transfer of
wealth from bondholders to shareholders, (ii) restructuring of incentive contracts, (iii) tax and regulatory advantages,
and (iv)improved focus and elimination of negative synergies. Among these explanations, the improved focus and
elimination of negative synergies hypothesis has received broad empirical support. Therefore, it is relevant to review
the extant literatures and develop my hypothesis for this investigation.
The transfer of wealth hypothesis argues that during corporate restructuring, the assets and liabilities are
restructured in a manner that involves a transfer of wealth from the bondholders and other stakeholders to the
shareholders of the firm. A recent example of wealth transfer through organizational restructuring has been cited in
Parrino (1997). In a case study of the Marriott spin-off, he shows that the restructuring not only reduced the
collateral on Marriott's existing debt but also reduced the bondholders claims on cash flows from the business. This
resulted in a large increase in the stock price and an associated decrease in the value of the firms debt. This research
provides apparent evidence of wealth transfer from bondholders to shareholders.
More generally, the restructuring of the incentive contract hypothesis asserts that the gains from corporate
restructuring arise from unique contracts after the restructuring, which improve the incentives of the different
stakeholders of the firm1. Schipper and Smith (1983) also investigated various regulatory motives for restructuring.
1

Aron (1991) argues that for a large, multiproduct firm, the stock price is a very noisy signal of any one divisional
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They argued that a regulated firm might reorganize a subsidiary in a manner that results in either the parent or the
subsidiary escaping the external constraint of regulation. A firm in the US may be able to restructure an overseas
subsidiary to avoid paying taxes on the income from that division. Although there do exist benefits to individual
firms from such motivations, on average, the authors do not find any evidence to support these hypotheses.
In a study of 78 spin-offs, Seward and Walsh (1996) found that after a spin-off, both the board of directors and
the compensation committees comprise mostly outside directors, suggesting that the implementation of restructuring
helps internal governance and control mechanisms to function efficiently. They also found that the compensation of
the CEO of the extracted subsidiary is typically based on corporate performance. However, they found that the gains
of corporate restructuring are not statistically related to these improvements in contracting efficiency.
Hite and Owers (1983), Schipper and Smith (1983), Daley, et al. (1997), and Desai and Jain (1999) assert that
the gains from corporate restructuring could arise from improvements in the firms focus and the elimination of
negative synergies between the parent and the subsidiary. Daley, et al. (1997) and Desai and Jain (1999) document
that in the year following a corporate restructuring event, the separate divisions that operate in different industries
show a significant improvement in their operating performance2. Hite and Owers (1983) classify firms based on the
reasons given by the firms for their corporate restructuring. They find that the subsample where the motivation was
improvement in focus exhibits the largest abnormal returns in the period from 50 days prior to the announcement to
the completion date of the corporate restructuring. Indirect evidence for the focus improvement motive is also
provided by Allen, et al. (1995), who examine whether the abnormal returns around corporate restructuring
announcement dates are a consequence of the correction of a prior mistake. They show that when corporate
restructuring is preceded by the acquisition of the division, the positive abnormal returns around the corporate
restructuring announcement dates represent the recreation of value that was destroyed at the time of the earlier
acquisition. The extant empirical evidence therefore indicates that the benefits of corporate restructuring arise
predominantly from the separation of diverse units, which improves focus and eliminates negative synergies
between divisions. Cusatis, et al. (1993) note significant long-term abnormal returns following corporate

managers productivity. Generally speaking, separation through corporate restructuring is accepted as the most
favorable signal since managerial compensation that is based on the productivity and efficiency of individual
divisions enhances managers incentives.
2
In particular, Desai and Jain (1999) use two other methods to identify focus-improving organizational
restructurings. They report that the improved operating and financial performance following corporate restructurings
is robust to the classification scheme.
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restructurings, but find that these returns are confined to the subsample of firms that are acquired within a three-year
period after the corporate restructuring. The authors suggest that corporate restructurings facilitate takeovers by
isolating specific divisions, which increases their value to the bidders. However, this increase in value may arise
from two distinct sources. It may be due to the elimination of negative synergies between the parent and the
subsidiary. An alternative explanation is that since the two entities are separate after the organizational restructuring,
the bidder can evaluate the separate entities better than before, thereby resulting in the mitigation of the standard
adverse selection problem that arises under information asymmetry.
There are several testable implications of the information hypothesis. First, firms that engage in organizational
restructuring should have higher levels of information asymmetry about their value than other firms. Second, the
abnormal returns at the restructuring announcements should be positive since undervalued firms engage in
organizational restructuring only in equilibrium3. Third, if information asymmetry results in undervaluation, then the
wealth gains from a corporate restructuring event should be positively related to the level of information asymmetry
about the firm. Furthermore, by separating the divisions through a divestiture, the individual divisions operating
costs and efficiencies are revealed to the market. Thus, the information hypothesis not only predicts a positive share
price reaction but also predicts that the level of information asymmetry will decrease for these firms after the
achievement of corporate restructuring. Since firms with different divisions operating within the same industry are
likely to have few negative synergies between divisions, when these firms undertake corporate restructuring, we
expect that information asymmetry is a more important explanation of the shareholder gains from the corporate
restructuring4. It is therefore expected that firms that have more growth options in their investment opportunity set
are liquidity constrained to engage in activities related to organizational restructuring. The consequent reduction in
information asymmetry lowers the financing costs for the firm. Finally, evidence that a corporate restructuring event
is followed by either the parent or the subsidiary raising more external capital than before will be consistent with the
information hypothesis.

Data and Empirical results

I identified the sample of firms that carried out corporate restructuring through divestitures, spin-offs, M&A, and

Nanda and Narayanan (1998) is a representative research that shows that undervalued firms tend to restructure
their organizations.
4
Schipper and Smith (1983) and Berger and Ofek (1995) explain the reason for this.
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so on, from the following sources: (1) stock distributions by firms trading on the first and second sections of TSE
(Tokyo Securities Exchange); (2) restructuring announcements in the business papers, including the Nikkei Daily
Newspaper, the Nikkei Financial Newspaper, and the Nikkei Industry Newspaper; and (3) restructuring
announcements during 20002004.
I collected financial and stock data of firms from the Nikkei Needs Financial Quest database and Eol Esper
provided by Eol Inc., Toyo Keizai Shinpousha kabuka database. Finally, I collected more than 600 samples from
these databases. My research objectives rest mainly on the restructuring between corporate groups. Finally, I
identified 61 cases of corporate restructuring in the initial sample. Table 1 provides summary information about the
main variables for this sample: sales, operating profits, total assets, and market value.
(Insert Table1 here.)
Besides, I can identify the distribution considered with respect to the restructuring method. According to this
exhibit, cooperative newly formed spin-off divestitures, newly formed divestitures, and absorbed divestitures
account for over 90% of my sample during 20002004.
(Insert Table 2 here.)

4.1

Event study methodology

Prior studies find positive abnormal returns around corporate restructuring announcement dates. We confirm these
returns by employing the event study methodology used by Chan-Lau (2002). We estimate a market model over a
280-day period ending 21 days before the corporate restructuring announcement.
In this study, we use the constant-mean return model because of its simplicity and robustness. Implementing the
model requires defining the event of interest and the event window, which is the period over which the prices will be
examined. Here, the event is defined as the date when the firm first announces its restructuring plan. The semi-strong
market efficiency hypothesis implies that the firms stock price will be affected by the announcement. Therefore, the
natural choice for the event window is the day of the announcement. However, based on standard procedures, a
2-day event window covering the announcement date and the subsequent day is chosen. To evaluate whether
information regarding the restructuring plans could have been spilled to the markets prior to the announcements, a
5-day event window covering the day preceding the announcement and the announcement date, a 10-day event
window centered on the announcement date, and a 20-day event window centered on the announcement date are
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analyzed as well.
The abnormal return on the stocks of firm i in period t, it, is defined as
it = Rit i

(1)

where Rit is the daily stock return of firm i in period t, and i is the mean daily stock return of firm i for the
280-day period before the first day of the event window. It is presumed that abnormal returns are normally
distributed with mean 0 and variance 2. The cumulative abnormal returns during the event period are given by
t2

CARi (t1 , t 2 ) = ARi ,t

t =t1

(2)

where t1 and t2 are the initial and final dates of the event window. The average cumulative abnormal return is derived
by averaging across all firms in the sample.

CARi (t1 , t 2 ) =

1
N

AR

i ,t

i =1

(3)

The variance of the cumulative abnormal returns for firm i can be expressed as

(4)
where is a vector with 1 in the positions from t1 to t2 and 0 elsewhere. The variance of the average cumulative
abnormal return is then computed as

Var CAR(t1 , t 2 ) = (t1 , t 2 ) =

2

1
N2

i =1

2
i

(t1 , t 2 )
(5)

Since CAR is assumed to be normally distributed with mean 0 and variance 2 (t1, t2), the J1 statistic is defined as

J1 =

CAR (t1 , t 2 )

(t1 , t 2 )
2

~ N (1,0)
(6)

J1 is normally distributed with mean 0 and variance 1.

4.2

Empirical result

Table 3 briefly shows the descriptive statistics of the abnormal returns of the acquirer and target. Table 4
summarizes the abnormal returns over different time intervals around the announcement dates for the sample of
firms that engaged in some type of restructuring, including spin-offs and subsidiary sales. Figure 5 shows the
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variations in the cumulative abnormal returns of the samples of both acquirers and targets during the event period.
(Insert Table 3 here.)
Table 4 reveals that both the acquirer and the target have an affirmative indication about the cumulative abnormal
returns during the event windows. I obtained significant cumulative abnormal returns on the stocks of the acquirers
and the targets in the 1- and 2-day event windows, which is consistent with the initial hypothesis. In particular, the
cumulative abnormal returns of the target firms in the 1-, 2-, and 5-day event windows present a significant result on
the statistics. The cumulative abnormal returns of the target firms increase, on average, approximately over 2%
during the period before and after 5 days of the corporate restructuring announcement. These facts imply that a
corporate restructuring announcement might dissolve any information asymmetry between firms and investors.
(Insert Table 4 and Figure 5 here.)
On the other hand, the stock price reactions before and after the announcement lead to the inference that investors
did not assess the restructuring plans of firms as highly impressive in the enhancement of corporate value. It appears
that the longer the event period, the smaller is the reaction of the abnormal returns of acquirers; this is specifically
the case 5 days after the announcement date. Further, when I extend the event period to 10 or more days, it appears
difficult to draw a feasible result from Table 3. From the perspective of an efficient market, the information about
corporate restructuring is gradually incorporated into the stock price while some time lag is available Information on
corporate restructuring spreads rapidly through the securities market via the Web and newspapers. This information
is believed to reflect in the future stock prices of the acquired firms as well as the target firms. However, owing to
market efficiency, this type of information is easily reflected in market price formation, so the research results do not
present a clear picture.

Multivariate analysis of divestiture choice

5.1

Logit model of divestiture choice

In this section, I construct an ordered logit model to examine how economic factors, including cash flow, stock
price, tax, leverage, and financial reporting considerations, taken together, influence the probability of choosing a
cooperative organization creation method over other methods, such as a spin-off or absorbed divestiture method.
Our goal is to identify the key factors in the decision. For various benefits, our inferences should be interpreted in the
light of possible correlations between our proxies. In terms of the extent of freedom from parent companies and
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main shareholders, there is a certain order among cooperative newly formed spin-off divestiture (CNF), newly
formed divestiture (NFD), and absorbed divestiture (AD). In this respect, managers can exercise the most discretion
in CNF. On the other hand, it is not necessary to have a considerable amount of cash to establish a company if one
opts for the absorbed divestiture method since shares can be used instead of cash.
It is hypothesized that the structure of corporate restructuring depends in part on the managements desire to retain
control of the business segment. Zingales (1995) suggests that a carve-out should be favored when there are benefits
of control to the parent. For example, maintaining control of a subsidiary in an industry related to the parents line of
business could lead to tangible or intangible operating synergies. Tangible relationships could include joint
development of shared technologies or production processes and joint procurement or distribution systems.
Intangible relationships result from sharing knowledge or capabilities. If the subsidiary is entirely unrelated to the
parent, access to the private information of, or exclusive relationships with, the subsidiary is likely to be of little
value to the parent firm. In support of this proposition, Schipper and Smith (1983) and Hite and Owers (1983) find
that a spin-off of an unrelated industry generates positive abnormal returns. Therefore, firms that can benefit from
controlling the subsidiary are predicted to choose a carve-out, and firms that have no benefits of control are likely to
choose a spin-off. This leads to the first hypothesis:
H1: Ceteris paribus, the probability of choosing a divestiture method is increasing in the value of control of the
subsidiary.
To test this hypothesis, I use total assets as a proxy variable of control of the subsidiary. The reason why I
choose this variable is that the size of a company affects the control of its subsidiary. This total assets variable
(ASSET) is measured as the log of the total assets in the year of the event, as an alternative measure of the entire
companys riskiness in the year of the event.
It is predicted that managers choice of the divestiture method depends on the need for finance. The choice may
be driven by the parent corporations need for cash to fund growth, pay back debt or other liabilities, or for
distribution to investors. The existing literature contains mixed evidence regarding fund constraints as a determinant
of choice of the divestiture method. Alford and Berger (1999) and Maydew, et al. (1999) find that the more cash
constrained a firm is, the greater the influence of cash flow need on the choice of the divestiture method. This leads
to the second hypothesis:
H2: Ceteris paribus, the probability of choosing a divestiture method is an increasing function of the firms need for
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cash.
To test this hypothesis, I use two proxies suggested by Maydew, et al. (1999). The first measure I adopt is free
cash flow (CF). This captures the difference between the firms internal supply of funds and desired investment in
the year prior to the divestiture. It is the difference between the parents operating income before depreciation and
the first difference in the total assets. The second measure is the current ratio (CR), which is used to assess the need
for liquid funds because of cash constraints. These variables are all divided by total assets.
Zingales (1995), Slovin, et al. (1995), and Nanda (1991) argue that overvalued subsidiaries should be sold out
while undervalued ones should be spun-off to incumbents in order to maximize the current shareholder value. Firms
with subsidiaries that are undervalued would rather not dilute their shareholder wealth and distribute the shares to
incumbents. Firms with subsidiaries that are overvalued have the opposite incentives. If the subsidiary belongs to a
growth industry or is outperforming industry peers, its market value is expected to increase due to buyer demand,
and the divestiture method the parent chooses depends on how the subsidiary increases its profit. Hence, it is
anticipated that firms with highly attractive or promising subsidiaries are more likely to divest through newly formed
divestiture than cooperative newly formed divestiture. This generates the fourth hypothesis:
H3: Ceteris paribus, the probability of choosing a divestiture method is an increasing function of the market
attractiveness of the subsidiary.
The potential demand for shares is tested using a growth measure of the divested units industry. PBR is the
ratio of the market price of the shares to the book value per share. This variable is a proxy for a growth measure in
the year of the divestiture. We also use an industry-relative measure of profitability (ROA) as a measure of the firms
market value. ROA is the return on assets in the year of the divestiture. Based on the findings of Smith and Watts
(1992) and Michaely and Shaw (1995), we also include leverage (LEV), measured as long-term debt divided by
total assets in the year of the event.
Based on the above discussion, I construct the following research model, which includes the designated
variables.

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Pr( y1 y 3 ) = 0 + 1CF + 2 LEV + 3 ROA + 4 PBR + 5 CR + 6 ASSET + 0 (1)

Pr( y 2 y 3 ) = 0 + 1CF + 2 LEV + 3 ROA + 4 PBR + 5CR + 6 ASSET + 0 (2)
Pr( y 3 y1 ) = 0 + 1CF + 2LEV + 3ROA + 4PBR + 5CR + 6ASSET + 0 (3)
+ 2LEV + 3ROA + 4PBR + 5CR + 6ASSET + 0 (4)
Pr( y 3 y 2 ) = 0 + 1CF
+ 2LEV

+ 6ASSET

Pr( y 2 y1 ) = 0+ 1CF
+ 3ROA
+ 4PBR
+ 5CR
+ 0 (5)
1CF
+ 2LEV

+ 4PBR
+ 5CR
+ 6ASSET

Pr( y1 y 2 ) = 0+
+ 3ROA
+ 0 (6)
where yi denotes a parameter of choice for the divestiture method. Thus, Pr(y1/y3), the choice of the divestiture
method, takes the value 1 if newly formed divestiture (NFD) is favored over absorbed divestiture, and 0 otherwise.
Pr(y3/y1) represents the reverse situation. Pr(y2/y3) takes the value 1 if cooperative newly formed divestiture is
chosen against absorbed divestiture, and 0 otherwise. Pr(y3/y2) represents the reverse situation. Pr(y2/y1) takes the
value 1 if cooperative newly formed divestiture is chosen against simple newly formed divestiture, and 0 otherwise.
Pr(y1/y2) represents the reverse situation. CF is the free cash flow, computed by subtracting the investing cash flow
from the operating cash flow. LEV is a leverage ratio that represents the debt to equity ratio. ROA is the parent
firms (acquirers) ROA and PBR is the parent firms price to book ratio. CR is the current ratio and ASSET is the
logarithm of the total assets in the year of the event. However, the dependent variables take multiple nominal values,
so typical regression cannot be used. Therefore, in this research, I test the ordered logit regression and estimate the
result using the maximum likelihood method.
Table 5 shows the descriptive statistics of each variable and the correlation matrix among the variables.
(Insert Table 5 here.)
5.2

Empirical result

The use of a multivariate model allows us to assess the relative importance of each of the independent variables
on the choice of the divestiture method. Table 6 shows the empirical result for this research design. Briefly, these
results imply that the choice of cooperative newly formed divestiture holds the key to interpret the entire picture.
Almost all coefficients related to the newly formed divestiture are significant.
(Insert Table 6 here.)
To the best of my knowledge, the management initially seems to rely on the choice of cooperative newly
formed divestiture. Further, the coefficients of the variables of corporate leverage and total assets reveal insignificant
results, which indicate that size and risk do not have much influence on the managements corporate divestiture
decision. The coefficients of ROA are negative and statistically significant if the management prefers cooperative
- 16 -

newly formed divestiture to other divestiture methods. On the other hand, the coefficients of PBR are positive and
statistically significant if the management prefers other divestiture methods over cooperative newly formed
divestiture. This result indicates that regarding cooperative newly formed divestiture, the management appears to
concede that the accomplishment of cooperative newly formed companies is accompanied with the loss of
efficiency; however, if it chooses other divestiture methods, it also seeks to gain the chance of growth through
divisive decision-making.

Suggestion
The purpose of this study was to examine divisive corporate restructurings in which a firm makes a subsidiary

public. This paper contributes to the literature on divisive corporate restructurings by expanding the findings of
Michaely and Shaw (1995), Maydew, et al. (1999), and the subsequent literature to include a broader sample of
firms and a richer multivariate model that includes additional variables. This expanded model increases the
knowledge of public divestiture choice by confirming some of the prior results on market reaction to divisive
decisions as well as demonstrating where differences lie between the divestitures of corporate subsidiaries,
especially in Japan.
The characteristics of a sample of 61 firms representing newly formed divestiture, absorbed divestiture, and
cooperative newly formed divestiture exclusive to the Japanese legal system over 20002004 were examined.
Similar to the findings of Maydew, et al. (1999), I found that cash need is associated with the occurrence of a
specified divestiture method. I also found that as a divesting firms cash need increases, the firm is more likely to
divest through newly formed divestiture. This evidence further supports the findings of Allen and McConnell (1998),
which suggest that firms divest by making their subsidiaries public because they are cash constrained. Additionally,
contrary to the findings of Michaely and Shaw (1995), I find no differences in size and leverage across the parent
firms. According to these authors, their findings indicated that parent firms that have difficulty accessing the IPO
market will spin-off a subsidiary rather than carve-out. The results of my study, on the other hand, suggest that the
markets demand for the subsidiary plays a significant role in the choice of the divestiture method, implied from the
evidence about PBR. The results suggest that carve-outs are an increasing function of the growth of the subsidiary
industry and the profitability of the subsidiary. This implies that the asset quality of the divested assets affects the
ability to access the market and the choice of the divestiture method, lending additional support to the findings of
- 17 -

Slovin, et al. (1995) and Zingales (1995).

The role of consolidation for financial reporting purposes was also considered and may have an impact on the
choice of the divestiture method. In this research, it appears that firms attempting to carry out cooperative
restructuring do not prefer earnings maximization. However, this result is confusing. Therefore, some questions
remain as to whether the significant coefficient of subsidiary profitability can be attributed to a desire to improve the
reported financial results or whether it is a measure of market demand for the subsidiary.
Despite this result, knowledge of divestiture choice provides insights into the source of the value gains
associated with divisive restructuring. The selection of the divestiture method, in light of certain firm characteristics,
may also provide insights into managers information about the subsidiary, reducing the information asymmetries of
investors. Additional knowledge of why firms structure their divestitures in the fashion they do will provide insights
into why firms divest in general, due to the fact that the net benefits of doing so depends on the method used. One
direction for future research would be to examine the method of choice among restructuring groups where the
economic impact of all of the factors may be more complicatedly connected. How these variables interact to
motivate a managers choice of the divestiture method interests me. Clearly, the wide range of post-divestiture
ownership suggests that varying motivations are factored into the decision. Finally, the role regulatory bodies play
in the structure of divestitures in regulated industries could be explored. As mentioned previously, Japanese
industries became gradually deregulated in the field of M&A and divestitures. Such a change of regulations affects
their business practices. Perhaps it would be beneficial to understand the impact of these changes on the corporate
structure.

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Figure 1 Divestiture schemes in Japan

Xshareholders

Xshareholders

Company X

Company X

Department
A

Xshareholders

Company X

A company

Xshareholders

Yshareholders

A company

Yshareholders
Xshareholders

Yshareholders

Company Y
Company X

Company Y

Company X

Company Y

Department

Department

Figure 2 Cooperative newly-formed spin-off divestiture

- 21 -

Shareholders

shareholders

a+a

Shareholders

b+b

Shareholders Shareholders

a+a

Shareholders

Shareholders

b+b

a+a

Shareholders

ab

Figure 3 Cooperative absorbed divestiture

shareholders

shareholders

b+b

shareholders

c+c

shareholders shareholders

a+b+c

shareholders

shareholders

a+b+c

Figure 4 Stock transfer and stock for stock merger

- 22 -

shareholders

shareholders

Stock for stock merger

Stock transfer

Company A

New establishment
Company P

Company B

Company C

Company A

Company P

Company B

Company C
They were
ex-s/h C

Including
ex-s/h B

Figure 5 Cumulative abnormal returns of acquirers and targets

0.02
0.015
0.01
0.005

19

17

15

13

11

-1

-3

-5

-7

-9

-0.005

-1
9
-1
7
-1
5
-1
3
-1
1

-0.01
-0.015
-0.02
-0.025
-0.03
-0.035

Table 1 Descriptive statistics

Sales
Operating profit
Total Assets
market value

mean
1700988
42259.88
3208282
4.98E+11

Std.Dv. Q1
median
Q3
(million yen)
3006821 1322452
350459
85692
105829.7
51550
10160
1092
7724008 3794923
587545
90427
1.29E+12 3.82E+11 9.98E+09
0

Table 2 Distribution of the number between groups (4/1/1999 ~ 3/31/2004)

- 23 -

acquirer
target

Stock transfer

1.6%

Stock for stock merger

4.9%

Cooperative newly formed divestiture

16

26.2%

Newly formed divestiture

19

31.1%

Absorbed divestiture

22

36.1%

Total

61

100%

Table 3 Descriptive statistics for abnormal returns of acquirer and target

Average abnormal return during event window
Acquirer

Target

Mean

0.000393

0.000564

Standard Deviation

0.003509

0.0059597

3Q

0.002534

0.002318

Median

0.000634

0.00027

1Q

0.00269

0.005214

Number

41

41

Table 4 Cumulative abnormal returns and statistical significance

Acquirer CAR

Target CAR

Panel A

1-day event window including the announcement date and the day after

CAR

0.010941

CAR

0.026544
- 24 -

J1

3.7731

J1

10.77818

p-value

0.000478

Panel B

2-day event window including the announcement date and the day after

CAR

0.015107

CAR

0.022214

J1

4.266587

J1

5.428928

p-value

0.000104

*** p-value

Panel C

5-day event window including the announcement date and the day after

CAR

0.006703

CAR

0.02357

J1

1.226316

J1

2.408843

p-value

0.226602

p-value

0.023

Panel D

10-day event window including the announcement date and the day after

CAR

0.00281

CAR

0.016209

J1

0.22104

J1

1.131011

p-value

0.99999

p-value

0.268

Panel E

20-day event window including the announcement date and the day after

CAR

0.016094

*** p-value

0.000

0.000

CAR

0.02313

- 25 -

***

***

***

***

J1

0.674213

J1

0.65714

p-value

0.503703

p-value

1.000

Panel F

2-day event window of the announcement date and the next day

CAR

0.007944

CAR

0.017874

J1

3.368092

J1

5.594269

p-value

0.001582

p-value

0.000

Panel G

2-day event window of the announcement date and the day before

CAR

0.008145

CAR

0.019194

J1

5.605766

J1

13.62713

p-value

1.28E-06

*** p-value

**

***

0.000

***

***, **, and * denote significance at the 1%, 5%, and 10% levels (two-sided tests), respectively.

Table 5 Descriptive statistics for a ordered logit regression

Panel A: Descriptive statistics

Variable

Mean

Std Dev.

Q1

Median

Q3

Current Ratio

91.17253

65.61984

101.44

83.43

50.16

75

Leverage(D/E)

4.496995

7.306063

5.27

2.25

0.93

68

Parent ROA

0.044233

0.055106

0.0566

0.0374

0.0178

81

Parent PBR

3.295117

16.68813

1.83

1.25

0.75

77

- 26 -

FreeCF/Assets

0.021835

0.043715

0.0472

0.021

0.0027

63

Log Assets

13.28903

2.088894

15.149

13.284

11.412

100

Panel B: Pearson correlation matrix

leverage D/E
current ratio
parent PBR
parent ROA
FreeCF/Assets
Log Assets

leverage D/E current ratio parent PBR parent ROA FreeCF/Assets Log Assets
1
-0.107
-0.0961
-0.3042
0.0126
0.1973
1
-0.1307
0.2089
0.0165
-0.4381
1
-0.0281
-0.0352
-0.0078
1
-0.17
-0.2301
1
-0.0474
1

- 27 -

Table 6 Specification and power of the ordered logit regression for identification

Intercept CF

LEV

ROA

PBR

CR

ASSET

0.02
(0.05)

-0.68
(0.00)

-0.40
(0.25)

0.02
(2.40)

-0.39
(1.51)

(1)

NFD/AD

3.84
(0.63)

4.88
(0.17)

(2)

CNF/AD

-12.66
(3.05)*

31.20
-0.00
(4.06)** (0.00)

-35.86
2.21
0.04
0.43
(4.83)** (4.85)** (4.54)** (1.09)

(3)

ADNFD

-3.84
(0.63)

-4.88
(0.17)

0.68
(0.00)

-31.20
0.00
(4.06)** (0.00)

-0.40
(2.18)

0.40
(0.25)

-0.02
(2.40)

0.39
(1.51)

(4)

ADCNF

12.66
(3.05)*

(5)

CNF/NFD

-16.51
26.32
(5.57)** (3.09)*

-0.02
(0.04)

-35.18
2.61
0.01
(3.84)** (5.66)** (2.36)

0.82
(3.77)*

(6)

NFD/CNF

16.51
-26.32
(5.57)** (3.09)*

0.02
(0.04)

35.18
-2.61
-0.01
(3.84)** (5.66)** (2.36)

-0.82
(3.77)*

***, **, * indicate 1%, 5%, and 10% significance, respectively.

- 28 -

35.86
-2.21
-0.04
-0.43
(4.83)** (4.85)** (4.54)** (1.09)

The number in parenthesis presents a chi-square value.

R2

0.34

30.79***

observatio

41