Governance, Interest Alignment and Corporate Spinoffs

The fact that spinoff creates value is well established in the extant literature. I maintain that spinoff creates value by providing an opportunity for firms to improve interest alignment through re-contracting CEOs incentives for both the spinoff parent and the spun-off firms, thereby reducing agency costs. Using pay-performance sensitivity to proxy for interest alignment, I find that for the parent firms, spinoff brings a closer association between the change in the CEOs pay and (1) lagged stock return for three consecutive years after spinoff, (2) contemporaneous return on equity (ROE) for two consecutive years after spinoff. Similarly, for the spun-off firms, spinoff also brings a closer association between the change in CEOs pay and both stock returns and ROE for two consecutive years after spinoff. Although I do not find evidence to support my conjecture that focus-increasing spinoffs yields a stronger interest alignment as compared to non focus-increasing spinoffs, this finding is still consistent with the result from Daley et al. (1997).;Following the contention from corporate governance and agency theory literature, I further examine the impact of corporate governance towards the interest re-alignment benefit from spinoff transaction with respect to four corporate governance mechanisms: board structure, committee independence, board and committee meetings and ownership structure. I find that the overall corporate governance of both the parent and spun-off firms are associated with the interest alignment improvement from the spinoff transaction. In addition, the change in committee independence is associated with the interest alignment of parent firms after spinoff. However, I do not find any association between change in corporate governance and the interest alignment of spun-off firms. The absence of results for spun-off firms may due to its small sample size. Moreover, for both parent and spun-off firms, the interest alignment improvement for stronger governance firms is not significantly differ from the weaker governance counterparts. This finding is still consistent with the non-linear nature of corporate governance benefits documented from prior literature.;In sum, my study document evidence that spinoff promotes interest alignment between CEO and shareholders and corporate governance in spinoff firms matters towards this improvement. These findings are complement to the established literature that spinoff creates value from agency cost reduction.