Arthur Andersen Center for Financial Reporting Research Workshop

Friday, February 14, 2020

11:00 a.m. – 12:30 p.m.

4151 Grainger Hall

The Effect of Financial Reporting for Restructuring on Firm Choice of Divestiture Form

Diana Weng Doctoral Candidate University of Florida

FACULTY Ph.D. STUDENTS W. Choi T. Ahn M. Covaleski J. Ariel-Rohr F. Gaertner I. Baek E. Griffith A. Carlson S. Laplante D. Christensen T. Linsmeier Z. King D. Lynch M. Liang E. Matsumura B. Osswald B. Mayhew C. Partridge T. Thomas L. Rousseau D. Wangerin D. Samuel T. Warfield M. Vernon J. Wild K. Walker K. Zehms E. Wheeler

The Effect of Financial Reporting for Restructuring on Firm Choice of Divestiture Form

Diana Lynn Weng

Fisher School of Accounting Warrington College of Business University of Florida Gainesville, FL 32611 Office phone: (352) 273-0227

February 2020

** Do not quote without the author’s permission **

I thank my dissertation committee members Bobby Carnes, Marcus Kirk, Mike Ryngaert, and Jenny Tucker (chair) for guidance; Elia Ferracuti, Jennifer Glenn, Patrick Kielty, Jeffery Piao, and Mark Zakota for comments; and Jonathan Urbine for his assistance with the SEC filings.

The Effect of Financial Reporting for Restructuring on Firm Choice of Divestiture Form

ABSTRACT

I examine whether financial reporting for restructuring influences managers’ choice of divestiture form. Firms have three major divestiture form options: a firm can sell a unit to another firm in a sell-off; sell a percentage of shares in a unit to new shareholders in an equity carve-out; or separate a unit and pro-ratably distribute the new unit’s shares to existing shareholders in a spin-off. My study is set around a financial reporting change, adopted in FAS 146 in 2002 and FAS 141(R) in 2007 for two different types of restructurings, that delays the recognition of restructuring charges until the costs are incurred. Prior to this reporting change, firms could recognize restructuring charges before they were incurred—a “big bath” opportunity that may enable financially struggling firms, which tend to divest through sell-offs, to show improvement after the completion of a restructuring. After the reporting change, firms must delay the recognition of restructuring charges until they are incurred, thereby reducing the opportunity for a “big bath.” I predict and find that the accounting change makes the sell-off divestiture form less desirable and therefore increases the likelihood of divestiture through a spin-off. Overall, my findings suggest that financial reporting for restructuring influences managers’ choice of divestiture form. This paper contributes to the literature on the real effects of accounting by providing evidence that financial reporting rules influence execution of a decision.

Keywords: restructuring, divestiture, financial reporting

Data availability: Data publicly available from the sources identified in the paper.

JEL classification: M41; G34; L22

1. Introduction

I examine whether financial reporting for restructuring affects managers’ choice of divestiture form. How accounting choices affect a firm’s real decisions is an important issue. Prior research finds that financial reporting choices influence whether firms execute a decision, for example, whether firms allocate resources to research and development (Graham, Harvey, and

Rajgopal 2005; Shroff 2017). There is limited research, however, that investigates the effect of financial reporting choices on how firms execute their decisions. Financial reporting for restructuring likely affects divestiture form choices because restructurings and divestitures are intertwined. A restructuring involves changing a firm’s business strategy or structure and a divestiture results in contracting the firm’s existing boundaries (Weirich 1995; Rahman 2011). If a firm divests, the divestiture is considered a part of a restructuring plan that culminates in the divestiture. Therefore, I expect financial reporting for restructuring to influence managers’ choice of divestiture form. Examining the effects of accounting choices on the selection of divestiture form addresses how firms execute existing decisions and provides new insights into the real effects of accounting choices.

A restructuring with a divestiture as the outcome typically includes two steps. First, the firm creates and commits to a restructuring plan. Second, the firm executes the plan by changing its business structure to prepare to divest and then divesting the unit. If the restructuring plan involves a merger & acquisition (M&A), the firm first expands its business through an M&A, changes its business structure to integrate the acquired units, and then divests unwanted units.

Regarding the divestiture portion of a restructuring, a firm first decides whether to divest a unit and then decides how to divest that unit (i.e., the divestiture form).

1 Divestitures are economically significant with deal activity growing from $100 billion in

1993 to over $2.2 trillion in 2018 and in total representing a third of all M&A activity (Brauer and

Wiersema 2012; J.P. Morgan 2019). Divestitures are projected to continue in prominence with at least 80% of large companies planning to divest by the end of 2021 (EY 2019).

I examine three divestiture forms: sell-offs, equity carve-outs, and spin-offs. In a sell-off, the parent company sells a unit to another company. In an equity carve-out, the parent company sells a percentage of shares in a unit in an initial public offering (IPO) and retains ownership of the remaining shares. In a spin-off, the firm separates a unit from its business, creates a new entity with the unit, and distributes the entity’s shares to existing shareholders on a pro-rata basis.

Firms typically weigh two motives in selecting a divestiture form—financial underperformance and strategic motives. The financial-underperformance motive primarily stems from a firm’s need to divest in order to improve financial performance. Firms driven by this motive often divest through a sell-off or equity carve-out (Duhaime and Grant 1984; Allen and

McConnell). Sell-offs and equity carve-outs both raise cash; however, a sell-off is the quickest and least costly form of divestiture because it is the only method that does not create a new entity, a process which involves more parties and greater costs. The strategic motive involves repositioning, refocusing, or reducing agency costs (Sudarsanam 2003). This motive is often driven by corporate governance mechanisms (e.g., institutional investors and boards of directors) and the need to reduce information asymmetry between management and other parties. Firms driven by a strategic motive often divest through a spin-off or equity carve-out (Krishnaswami and Subramaniam 1999;

Vijh 2002). These divestiture forms allow for the reduction in information asymmetry while allowing original shareholders to maintain ownership in the divested unit. A firm may have some level of each motive, but the dominating motive facilitates the firm’s choice of divestiture form.

2 Investors expect improved financial performance after a restructuring is complete. The pressure to show improvement is even greater for financially underperforming firms because the primary objective of these firms’ restructurings is to address underperformance. In contrast, the objective of strategic divestitures is part of a long-term goal of shifting a firm’s strategy or focus.

Therefore, firms with strategic divestitures face less pressure to show performance improvements in the near term.

Financial reporting for restructuring can influence a firm’s choice of divestiture form depending on whether an accounting choice allows the firm to meet performance expectations after the completion of a restructuring. One such choice is a “big bath”—shifting the recognition of certain restructuring charges from post-divestiture to pre-divestiture and thus increasing the likelihood of meeting post-divestiture expectations (Moehrle 2002). In other words, firms may overstate restructuring charges (which are considered non-recurring negative items and therefore draw less attention from investors) in the current period to boost earnings in future periods when they avoid recording income-reducing items related to the restructuring (Duncan 2001). In addition, earlier recognition of restructuring charges may allow managers to overestimate restructuring charges and justify the overestimation. A longer time lag between recognition and occurrence of the event means the firm has less information and more flexibility in estimating the charges at the recognition. A firm may use this flexibility and create a “big bath.” Therefore, changes in financial accounting for restructuring that affect managers’ big-bath opportunities may influence their choice of divestiture form.

The financial reporting change for restructurings without an M&A (non-M&A firms) occurs at a different time than the change for restructurings with an M&A (M&A firms). For non-

M&A firms, firms followed EITF 94-3 since 1995 and were allowed to report restructuring charges

3 as early as the restructuring plan commitment date. FAS 146 “Accounting for Costs Associated with Exit or Disposal Activities,” effective in 2003, requires firms to delay the recognition of restructuring charges until they are incurred and therefore reduce firms’ opportunities to frontload charges. For these firms, I refer to 1995-2002 as the pre-period and 2003-2018 (my final sample year) as the post period. For M&A firms, firms followed EITF 95-3 since 1995 and were allowed to report restructuring charges as soon as the M&A completion date, well before executing the restructuring plan. FAS 141(R) “Business Combinations,” effective in 2008, also requires firms to delay the recognition of restructuring charges until they are incurred. For these firms, I refer to

1995-2007 as the pre-period and 2008-2018 as the post-period. Examination of FAS 146 and FAS

141(R) allows me to study the real effects of a change in financial reporting, how a reduction in the opportunity to manage restructuring charges can influence the selection of divestiture form.

The reporting changes reduces firms’ ability to manage earnings through a “big bath” in the post-period compared with the pre-period and thus creates greater challenges for firms to show immediate, improved performance after the restructuring is complete. All else equal, the greater challenges decrease a firm’s likelihood of achieving the primary purpose of restructuring under the financial-underperformance motive—showing improvements in financial performance. The firm may shift its motives for restructuring from the financial underperformance motive to the strategic motive. Therefore, I expect sell-offs to be less desirable by managers after the accounting change, tipping the scale for spin-offs and equity carve-outs as the selected divestiture forms under the new accounting rules for restructuring.

I use 950 hand-collected divestiture firm-years (468 sell-offs, 149 equity carve-outs, and

333 spin-offs) to investigate whether the change in financial reporting for restructuring affects the choice of divestiture form. I use a multinomial logit model to examine the choice among the three

4 divestiture forms. I find that firms increase their selection of spin-offs compared to other forms after the financial reporting change. Among sell-offs and equity carve-outs, firms increase their selection of sell-offs compared to equity carve-outs. The increased desirability of spin-offs over sell-offs is expected, but the increased desirability of sell-offs over equity carve-outs is contrary to my expectations.

In additional analyses, I investigate whether the reporting change differentially affects the divestiture form choices of M&A versus non-M&A firms as a plausible explanation for the increased desirability of sell-offs over equity carve-outs and the mechanism through which the change in selection of divestiture form occurs. The main set of analyses assumes that M&A firms and non-M&A firms shift their selection of divestiture form in the same manner after the reporting change. However, their responses could differ because M&A firms undergo a significant transaction that can influence the remainder of the restructuring, whereas non-M&A firms do not.

In additional analyses, I observe that the finding of increased likelihood of spin-offs relative to sell-offs is driven by non-MA firms. M&A firms maintain sell-offs as their preferred choice, likely to quickly offload unwanted units acquired in an M&A deal, whereas non-M&A firms increasingly choose spin-offs. I also observe that M&A firms drive the decreased choice of equity carve-outs in the main analyses. Prior to 2001 (early pre-period), M&A firms could liberally account for

M&As and equity carve-outs, i.e., firms followed very flexible rules to account for M&A and equity carve-out transactions. Outside of this early pre-period, I find no change in selection of equity carve-outs from the pre- to post-period. Therefore, the reduced selection of equity carve- outs in the main results can be attributed to liberal accounting for equity carve-outs in the early pre-period.

5 In addition, the main set of analyses assumes that strategic firms and financially underperforming firms shift their selection of divestiture form in the same manner after the reporting change. However, the firms’ responses could differ because I posit that the reduction affects financially underperforming firms more than it affects strategic firms. I find that in the post- period, financially underperforming firms are more likely than strategic firms to select sell-offs over spin-offs. Strategic firms increase their selection of spin-offs from the pre- to post-period, possibly due to financially underperforming firms pivoting their goals towards longer-term strategies and thus becoming strategic firms before divesting.

My study contributes to the literature in two ways. The first and primary contribution is to the literature on the real effects of accounting choices. The research in this area focuses on a first step, whether firms make a decision (e.g., Graham et al. 2005; Shroff 2017), but does not address the second step, how firms implement that decision. The first step has two options: yes or no. The second step has potentially infinite options. Whether the results from prior literature on the first step can be generalized to the second step (i.e., do accounting choices influence the second step?) is unclear. In addition, the choice among many options is more nuanced than the choice between two options (i.e., if accounting choices influence the second step, how does the selection among the options shift?) and thus inferring from prior literature is challenging. My study finds that accounting influences how firms implement their decision and in what manner.

Second, this paper contributes to the literature by connecting two areas of research: how financial reporting rules influence real decisions and the determinants of divestiture choice. Prior literature on the real effects of financial reporting investigates investment and/or operating decision (e.g., Graham et al. 2005; Shroff 2017) but not divestment decisions. Use of divestments uniquely provides a cleaner setting to investigate the real effects of accounting on how firms

6 implement their decisions. Firms publicly report how they execute their divestment decisions, specifically their choice of divestiture form, but implementation of investment decisions is not always publicly visible. Firms also have fewer divestment options but a much greater number of investment options, so examining the implementation of investment decisions is more challenging and noisier. Prior literature on the determinants of divestiture form provides evidence of operational and financial determinants, but does not consider the role of accounting or financial reporting. For example, firms divest through sell-offs when they need cash to reduce leverage

(Lang, Poulsen, and Stulz 1995) and through spin-offs when they have information asymmetry problems (Krishnaswami and Subramaniam 1999). Thus, examining the role of financial reporting in the choice of divestiture form connects these two areas of the literature and provides new insights into the role of accounting in shaping real activity: how firms implement their decisions.

2. Background

2.1 Divestitures

Sell-offs, equity carve-outs, and spin-offs are the three forms of divestitures. In a sell-off, the parent company sells its subsidiary to another company. For example, Citigroup Inc. sold

Diners Club International Ltd. to Discover Financial Services in 2008.1 In an equity carve-out, the firm sells a percentage of shares in a unit to new owners and retains ownership of the remaining shares. For example, Citigroup Inc. sold 54% of shares in its wholly-owned subsidiary Primerica

1 In a split-off, a firm separates a unit from the business and enters a share exchange agreement with the firm’s existing shareholders. Shareholders can opt out of the share exchange or exchange its shares in the firm to receive the unit’s shares. For example, McDonald’s Corp. reduced its ownership in Chipotle Mexican Grill Inc. from 82.2% to 0% in 2006 and, as a result, McDonald’s previous shareholders own either McDonald’s or Chipotle, but not both, after the split-off. I combine split-offs and sell-offs into one group and refer to them as “sell-offs” because they are both considered sales and equity shareholders lose a portion of their ownership and control (either percentage or amount) in the divestiture because split-offs are infrequent. Panel A of Appendix A provides additional details on combining divestitures.

7 Inc. in 2009.2 In a spin-off, the firm separates its unit from the business and distributes the unit’s shares to the firm’s existing shareholders on a pro-rata basis. For example, Marriott International

Inc. spun off Marriott Vacations Worldwide Corp. in 2011. After the spin-off, Marriott Vacations and Marriott International exist as independent companies.3,4 Figure 1 summarize these three forms of divestitures.

The three divestiture forms differ in three respects: (1) cash, (2) ownership and control, and (3) creation of a new entity. Sell-offs and equity carve-outs involve cash, whereas spin-offs do not. If a firm decides to divest and needs cash, sell-offs and equity carve-outs are more desirable than spin-offs. In a sell-off, previous owners maintain the same ownership and control, but the size of the divesting firm decreases. In an equity carve-out, owners maintain the same ownership and control in the parent company but lose a percentage of ownership and control in the divested unit.

In a spin-off, previous owners maintain the same ownership and control in the parent and receive pro-rata ownership and control in the spun-off unit. In other words, an owner owns x% of the parent and receives x% of the spun-off unit. Spin-offs and equity carve-outs create a new entity, whereas sell-offs do not.

2 Equity carve-outs have the following breakdown: 30% (53 / 174) have control (own 50%+) before the carve-out and lose control after the carve-out, 1% (2 / 174) never had control to begin with, and 68% (119 / 174) have control before the carve-out and maintain control. The original sample contains 174 equity carve-outs. Sample selection reduces the sample by 25 observations but maintains a similar breakdown. 3 In this example, if Marriott International has a total of 100 shares outstanding and an investor owns five shares, then that investor receives 5% of Marriott Vacations’ shares in the spin-off. 4 In a split-up, the firm separates all of its net assets into units, spins off all of its units, and then ceases to exist. For example, Hewlett Packard (parent) split up into HP Inc. (unit 1) and Hewlett-Packard Enterprise (unit 2). The split-up took two steps. First, the parent spun off unit 2 by distributing all of the parent’s ownership in unit 2 to the parent’s original shareholders. Second, the parent changed its name to HP with the SEC, so after separating unit 2, the parent becomes unit 1 without a share exchange or distribution. Investigation of three split-ups shows that other split-ups follow this same two-step procedure. I combine spin-offs and split-ups into one group and refer to them as “spin-offs” because both are accounted for as distributions and shareholders in both maintain the same ownership and control in the divestiture and because, in practice, firms file split-ups as spin-offs. Panel A of Appendix A provides additional details on combining divestitures.

8 2.2 Financial reporting for restructuring

In 1995, firms began following EITF Nos. 94-3 and 95-3, under which firms could accrue expenses and record liabilities for restructuring charges before incurring the restructuring costs.

Examples of restructuring charges include one-time termination benefits, contract termination costs (e.g., operating leases), costs to consolidate or close facilities, costs to relocate employees, among others (FASB 2002). A restructuring may involve an M&A, change in business structure, and/or divestiture. A “non-M&A firm” does not have an M&A in its restructuring, only a change in business structure to prepare to divest followed by a divestiture. EITF No. 94-3 allowed non-

M&A firms to record restructuring charges as early as the restructuring plan commitment date.

The commitment date is determined as the date when (1) management approves and commits the firm to a formal plan of restructuring, (2) the plan specifically identifies key components of the restructuring, and (3) plan actions are to begin “as soon as possible” (Weirich 1995).5 An “M&A firm” restructures by growing the business through an M&A, changing the business structure by integrating the M&A and preparing to divest, and lastly divesting. EITF No. 95-3 allowed M&A firms to record restructuring charges as soon as the M&A completion date.6 The restructuring plan commitment date and M&A completion date are often both before taking actual restructuring action, so firms estimated and recorded restructuring charges before they were incurred. The earlier recognition also increases flexibility in estimation of the charges, so firms could overestimate initial recognition of restructuring charges in this period.

In the decades prior to EITF Nos. 94-3 and 95-3, the number and amount of negative special charges (including restructuring charges) grew and created regulatory concern. This set of standard

5 Key components of the plan include all actions to complete the plan, operations to not be continued (method of disposition, locations of operations), and expected date of completion. 6 In my sample, 62.1% (590 / 950) of restructurings involved an M&A.

9 changes created a cut-off for when these charges could be accrued. Prior to these standards, firms could accrue restructuring charges even earlier. While EITF Nos. 94-3 and 95-3 may not seem appropriate today, they were a big step forward in reducing earnings management at the time (Bens and Johnston 2009).

However, the early recognition of restructuring charges in EITF Nos. 94-3 and 95-3 was inconsistent with the FASB’s definition of a liability (FASB CON 6, 1985); those charges did not create a present obligation to others, a critical component of the definition of a liability. FAS No.

146 notes that the restructuring charges reported at plan commitment date were before the actual expenses and liabilities were incurred. The FASB did not explicitly note concern over “big bath” restructuring charges in the statement; however, a few years after the implementation of EITF No.

94-3, SEC Chairman Levitt (1998) continued to raise concerns over “big bath” earnings management, especially restructuring charges. To remedy this discrepancy, the FASB introduced

FAS 146 in 2002, which became effective for non-M&A firms in 2003, and FAS 141 (R) in 2007, which became effective for M&A firms in 2009.7 After FAS Nos. 146 and 141(R) became effective, firms could only record restructuring charges when they are incurred, when they take actual restructuring actions. Therefore, firms must recognize restructuring expenses and liabilities later in the divestiture process compared to recognition under EITF Nos. 94-3 and 95-3. Figure 2 provides visual representations of restructuring charge recognition across the divestiture process under the two reporting regimes.

7 The delay between FAS 146 and FAS 141(R) is due to the standard-setting process. The FASB can only work on a limited number of projects at a time and each project takes a long time from the identification of a financial reporting issue to the issuance of new rules. For example, the FASB added accounting for restructuring charges for non-M&A firms to its agenda in August 1996, issued an exposure draft in June 2000, and issued the final rule of FAS 146 in June 2002. The FASB added accounting for business combinations to its agenda in 1996 and issued the final rule of FAS 141 (R) in December 2007.

10 This delay in recognition of restructuring charges is substantial. Of 1,552 divestitures for which the effective date is populated, the average firm had an effective date 100 days after the divestiture announcement. Of 1,023 divestitures for which the announcement and effective date are not the same day (in case of data entry error), the average firm had an effective date 151 days after the announcement date. The date of the related M&A’s completion or plan commitment date is likely much earlier than the divestiture announcement date. Thus, a very conservative estimate is that recognition of restructuring charges in the post-period is at least 151 days later than in the pre-period.

FAS No. 146 became effective for restructuring initiated after December 31, 2012, so the pre-period for non-M&A firms is 1995 to 2002, and the post-period is 2003 to present. FAS 141(R) became effective for acquisitions dates after December 15, 2008. To allow a year (2009) between

M&A and divestiture, the pre-period for M&A firms is 1995 to 2009 and the post-period is 2010 to present. Figure 3 provides a visual timeline of accounting rules for restructuring.

2.3 Effects of financial reporting on real decisions

Kanodia (2006) highlights the influence of financial reporting of underlying economic events on firms’ real decisions. He distinguishes this view from the view that accounting is a noisy signal of a firm’s liquidating dividend and the view that accounting is inconsequential to pricing or decision-making. Accrual accounting embedded in financial reporting rules requires estimates and therefore introduces some level of imprecision or inaccuracy in reporting and disclosure.

Kanodia argues that such imprecision influences a firm’s investment decisions. Investment choices are often not publicly observable and the reported investment amount includes some level of measurement noise due to the need to estimate expectations about the investment. Managers can

11 use the flexibility of estimation to communicate some private information about the investment.

While some information remains unknown, the market can infer part of it from the reported figure in order to value the firm. Managers therefore can invest and report the investment figure in a way to maximize the market’s valuation of the firm. Some level of imprecision can facilitate efficient investment levels, while other levels can induce over- or underinvestment.

This area of the literature stems from positive accounting theory (Watts and Zimmerman

1978, 1990), the theory behind determinants of accounting choice, and expands into the consequences of accounting choice (Fields, Lys, and Vincent 2001; Francis 2001). Positive accounting theory is the study of actual accounting choices, expanding beyond how we should ideally account for economic events to how we do account for them. It predicts that a firm’s real circumstances influence its accounting choice (Demski 1988) and that accounting has real implications. Accounting can affect agency costs and the welfare of managers and auditors (Watts and Zimmerman 1979). In addition, accounting choice has a role in contracting, reducing information asymmetry, and policy-making (Fields et al. 2001).

Prior research on the effects of financial reporting on firms’ investment decisions examines how incentives to report higher earnings influence firms’ investment decisions. The studies in this area find that managers sacrifice long-term, value-maximizing investments to report higher earnings (Bushee 1998; Bens, Nagar, and Wong 2002; Graham et al. 2005; Graham, Hanlon, and

Shevlin 2011). Shroff (2017) examines 49 changes in GAAP and provides evidence that changes in accounting rules affect investment decisions even when the rule is unrelated to financial reporting of the investment.

While these studies inform us of the role of accounting in firms’ real decisions, they are limited to investment decisions. An investment is the use of funds or capital towards a project or

12 objective, typically to generate a profit. Examples of investments are R&D, capital, and acquisition expenditures to enter new markets. A divestment, or divestiture, is typically seen as the opposite but more challenging decision compared to investment decisions (Boddewyn 1983; Porter 1976) due to the traditional view of divestitures signaling weakness (Dranikoff et al. 2002). To my knowledge, the literature has not examined the role of accounting in firms’ divestment decisions.

2.4 Determinants of divestiture choices

A majority of the management literature on the determinants of divestiture choices focuses on two areas: (1) whether to divest and (2) whether to divest in a specific form. Rahman (2011) categorizes the main determinants of divestiture into two groups: financial underperformance and strategy.8 Financial-underperformance motives include poor or underperformance and high leverage. When a firm has poor performance or high leverage, it is more likely to divest. Strategic motives include repositioning, refocusing, and reducing agency costs (Sudarsanam 2003). When a firm changes its strategy, for example by concentrating its efforts on its main operations, it is more likely to divest.

The second area, whether to divest in a specific form, is a subset of the first area. The studies in this area limit the divestiture choice to one form. Firms divest through a sell-off when they need cash to reduce leverage (Lang et al. 1995), when the firm is in financial distress or underperforming (e.g., Duhaime and Grant 1984), a particular unit experiences chronic poor financial performance (e.g., Ravenscraft and Scherer 1987), and the firm is overdiversified (e.g.,

8 Bergh (2017) categorizes the main determinants of divestiture into three groups: environment, corporate governance, and strategic problems. Environmental determinants include industry trends and social pressures. Corporate governance determinants involve agency theory (owners exerting their motivations over managers), boards of directors, and blockholder ownership. These first two determinants fall under Rahman’s (2011) strategic motives. Bergh’s discussion of strategic problems focuses on firms experiencing poor performance or not achieving optimal efficiency. This discussion falls under Rahman’s financial-underperformance motives.

13 Lang and Stulz 1994). Firms divest through a spin-off to reduce information asymmetry

(Krishnaswami and Subramaniam 1999). The information asymmetry stems from a diversification issue. When firms diversify, external stakeholders face increasing difficulty in forecasting performance and valuing the firm. Firms are more likely to divest through an equity carve-out to refocus the firm’s strategy (Vijh 2002) and to retire debt (Allen and McConnell 1998). Refocusing the firm’s strategy also stems from diversification. When firms diversify, they typically operate in several industries. Such diversification reduces the firm’s focus on its main operations. The main inference in this area is that when a firm needs cash to reduce leverage, it is likely to divest through a sell-off or equity carve-out over a spin-off.9

Fewer studies examine determinants of the choice among divestiture forms. Bergh and

Sharp (2015) examine outside versus inside equity ownership and the choice of divestiture between a sell-off and spin-off. They find that firms choose spin-offs over sell-offs when they have greater outside blockholder ownership and when the divested unit is larger. Slovin, Sushka, and Ferraro

(1995) is the only study to my knowledge that examines all three forms. They find that managers are more likely to divest through a spin-off or equity carve-out rather than a sell-off when investors are likely to price the new shares higher than managers’ perceived value.10,11

3. Hypothesis development

9 Another inference, but not the focus of my paper, is that when a firm is highly diversified or overdiversified, firms are likely to divest using any of forms. Because diversification is a determinant of all forms, this inference does not have strong implications for studying choice among the forms. 10 Slovin et al. (1995) examine share price effects of divestiture announcements, an ex post measure of ex ante decision-making. 11 Michaely and Shaw (1995) find that firms choose to divest through a spin-off over an equity carve-out when the firm is on average smaller in size, riskier, more leveraged, or less profitable. However, they investigate master limited partnerships to avoid tax and control issues; these firms are not in my study.

14 The management and finance literatures provide some evidence on how managers choose a divestiture form. In a review paper, Bergh (2017) calls for more research on the motives for different forms of divestitures. He points out that most of the literature examines the motives behind only one divestiture form and emphasizes the importance of examining “the full set of divestiture motives [behind sell-offs, spin-offs and equity carveouts to] … add to our knowledge of the divestiture process.” I answer this call by examining whether the earnings management opportunities through financial reporting of restructuring charges affect managers’ divestiture decisions. Divesting is part of the restructuring process, so financial reporting of restructuring could play an important role in choice of divestiture form.

Firms primarily restructure and divest for two major reasons: strategic and financial- underperformance motives. A firm may grow beyond its optimal size and lose its primary focus; a remedy is to restructure and divest so that the firm can concentrate on their primary operations, a long-term goal. In addition, a firm may cite underperforming units as the reason for the entire firm underperforming; a remedy is to restructure and divest so that the firm can improve future financial performance, a short-term goal. In choosing a divestiture form, firms weigh these two sets of motives and the dominating motive facilitates choice of form. Prior literature finds that strategic motives result in selection of spin-offs (Krishnaswami and Subramaniam 1999) or equity carve-outs (Vijh 2002), while financial-underperformance motives result in sell-offs (Duhaime and Grant 1984) or equity carve-outs (Allen and McConnell 1998). Sell-offs are highly desirable to financially underperforming firms for three reasons. First, they provide an influx of cash.

Second, they are the quickest and least costly form of divestiture. Third, it does not create a new entity, a process which involves more parties, filings, and costs. On the other hand, a change in strategy is often driven by corporate governance mechanisms or institutional investors, who seek

15 reductions in information asymmetry without reducing their ownership. Spin-offs accomplish these goals and are thus highly desirable to firms divesting with strategic motives.

Regardless of motive, the market expects firms to emerge from the restructurings and divestitures with improved performance—anticipating the benefits of the strategic shift or improvements from prior underperformance. However, the pressure to report higher earnings is greater for financially underperforming firms, which typically divest through sell-offs. Immediate improvement in post-divestiture performance is less critical for the long-term goals of a strategic divestiture. Financially constrained firms use earnings management to signal positive prospects

(Linck, Netter, and Shu 2013), so firms with dominating financial-underperformance motives are more likely to take earnings management opportunities.

One method for a firm to show improved financial performance after a sell-off is through acceleration of restructuring charges. Restructuring charge manipulation involves recognizing expenses and liabilities for restructuring actions that will be made to a company’s operations.

Nelson, Elliott, and Tarpley (2003) find that the most common expense/loss management method is the recognition of too much or too little reserve, including those of restructuring charges.

Restructuring charges are typically associated with a “big bath,” in which firms overstate restructuring expenses so the market disregards it as a large, non-recurring charge (Duncan 2001) and so the firm has a hidden reserve to increase future income (Moehrle 2002). Moehrle finds evidence of firms using restructuring reversals to beat analysts' forecasts and/or avoid reporting net losses and earnings declines. Early recognition of restructuring charges is viable choice for managers in my pre-period, in which accounting rules permitted firms to recognize restructuring costs before they are incurred.

16 Bens and Johnston (2009) find that fewer “big bath” opportunities result in lower reported restructuring charges. They investigate a reduction in discretion over reporting restructuring charges pre- and post-EITF No. 94-3 (pre-1995 and post-1995).12 In their pre-period, few rules for reporting restructuring charges existed, and regulators were concerned about growing restructuring charges (typically a component of special items). Bens and Johnston find that a significant portion of restructuring charges were overstated in this period. Issued in response to this concern, EITF

No. 94-3 delayed recognition of restructuring charges until the restructuring plan commitment date. The purpose of EITF 94-3 was to prevent companies from aggressively recording restructuring charges to enhance future earnings (Daniels, Rouse, and Weirich 1995).13 EITF No.

94-3 in Bens and Johnston’s study and the standard changes in my study have two parallels. First, both changes result in the delay of restructuring expense recognition. Second, both changes reduce the ability to manage earnings through a “big bath.” EITF 94-3 delayed restructuring recognition and reduced earnings management opportunities, and FAS 146 and 141(R) took them a step further. While Bens and Johnston provide evidence of the reduction in earnings management, they do not examine the influence of the reduction on real decisions.

Reducing opportunities to accelerate recognition of restructuring charges post-FAS 146 and FAS 141(R) can have implications for divestiture choice. A restriction in “big bath” opportunities weakens the financial-underperformance motive. When firms, especially underperforming firms, weigh the two sets of motives in the post-period, the strategic motive

12 The pre-period in Bens and Johnston (2009) precedes my sample period, and their post-period is my pre-period. 13 The incentives to and opportunities taken by firms to record higher expenses and/or manage earnings downward are not limited to restructuring charges. One of the earliest papers in this area is Jones (1991). Jones demonstrates that firms manage earnings downward during import relief investigations to obtain import relief. Other studies show that managers decrease current earnings before share repurchases, management buyouts, and executive option awards (Francis, Hasan, and Li 2015; Badertscher, Phillips, Pincus, and Rego 2014). In addition, managers reduce current earnings to increase their future compensation (Beneish 2001) and to confront the threat of political costs (Boland and Godsell 2019).

17 becomes relatively stronger compared to the pre-period. The desirability of a sell-off, the primary divestiture of financially underperforming firms (Duhaime and Grant 1984), declines in the post- period. Therefore, I expect that spin-offs and equity carve-outs are more desirable in the post- period compared to sell-offs. I state my hypothesis in directional form:

H1: A reduction in the opportunity to manage earnings through restructuring charges

increases firms’ selection of spin-offs and equity carve-outs and decreases

selection of sell-offs.

4. Data

I identify divestitures through Securities Data Company (SDC) Platinum and SEC filings.

I begin the identification process with SDC, which places restrictions on identification of some divestiture forms. An example of a restriction is 100% ownership of the unit before and/or 0% ownership of the unit after the divestiture. I do not require these restrictions for my study, so I expand the sample beyond SDC using three steps. First, I find the SEC filings for the SDC divestitures. I search for the parent and/or the unit and read filings near the SDC announcement date to determine how firms file divestitures with the SEC. Second, I extract the appropriate SEC filings associated with each divestiture form.14 Third, I read the filings to identify divestitures that are filed with the SEC but not included in SDC data.

My identification method expands the sample and improves the integrity of the data but restricts my sample to divestitures with public filings. SDC includes spin-offs with no regard to ownership percentage before or after, so SDC does not place a restriction on spin-offs. However, to maintain consistency in identification of the divestitures, I require that spin-offs have public

14 I thank Johnathan Urbine for assistance with this procedure.

18 filings. Therefore, I identify spin-offs using the SEC Form 10-12B filed by the spun-off unit. The

SEC requires firms to file spin-offs using Form 10-12B. I read all Form 10-12B filings to ensure that I only include spin-off filings. SDC restricts equity carve-outs and split-offs to only include those that represent 100% of the unit (i.e., the parent owns 100% before and 0% after). However, a firm can still divest through an equity carve-out or split-off without owning 100% before and 0% after the divestiture. I require the SDC equity carve-outs to have an SEC filing by either the parent or the unit.15 I identify split-offs using the three-step identification procedure. Lastly, SDC defines a divestiture (sell-off) as a loss of majority control or interest. I rely on SDC to identify sell-offs because use of Compustat or SEC filings results in significantly noisier proxies and inclusion of immaterial sell-offs. The other three divestiture forms are material transactions, so I seek to include only material sell-offs. I describe combination of sell-offs and split-offs into a single “sell-offs” form in Section 2.1. See Panel A of Appendix A for more details on identification of divestitures.

I identify 956 divestitures across 1995 to 2019: 369 sell-offs, 103 split-offs, 150 equity carve-outs, and 334 spin-offs. Spin-offs include both spin-offs and split-ups because in practice, firms file split-ups as spin-offs. After combining sell-offs and split-offs into the “sell-off” group,

I have 955 divestiture firm-years; the loss of one observation is due to a firm having a split-off and sell-off in the same year, and I include this observation as one firm-year. After requiring necessary control variables, my sample size is 950 divestiture firm-years: 468 sell-offs, 149 equity carve- outs, and 333 spin-offs. Table 1 summarizes my sample selection process. The pre-period of 1995 to 2002 for non-M&A firms and 1995 to 2009 for M&A firms has 254 sell-off, 108 equity carve- out, and 150 spin-off firm-years. My sample begins in 1995 because the pre-period reporting rules were issued in 1995. Prior to 1995, firms followed a different set of reporting rules. The post-

15 Firms announce or file their equity carve-outs with the SEC in many different types of filings. Expansion of equity carve-outs is too time-consuming at this time and will be explored later.

19 period of 2004 to 2019 for non-M&A firms and 2010 to 2019 for M&A firms has 214 sell-off, 41 equity carve-out, and 183 spin-off firm-years.

Figure 4 provides frequency distributions of each divestiture form across time. Panels A and C of Figure 4 show that sell-offs and spin-offs are relatively consistent over the sample period, with spin-offs exhibiting a slight U-shaped distribution. Panel B shows a sharp decline in equity carve-outs starting in the early 2000s.

Broadly, the restructuring and divestiture process involves committing to a restructuring plan, taking restructuring actions, and then divesting. In the pre-period, firms could recognize restructuring charges at the plan commitment date for non-M&A firms or the M&A completion date for M&A firms. In the post-period, reporting standards delayed recognition to when firms incur costs from restructuring actions. The change occurred for M&A firms in 2002 and for non-

M&A firms in 2007. To identify when a firm can recognize restructuring charges in its restructuring and divestiture process (i.e., whether that firm-year is in the pre-period or the post- period), I need to identify whether the firm is an M&A firm or a non-M&A firm. Because whether a divestiture is related to an M&A is seldom disclosed, I assume that that if the firm had an M&A in the year preceding the divestiture, then the divestiture is related to an M&A and thus that firm is an M&A firm in that firm-year. This assumption is reasonable because it provides sufficient time, one year, for firms to announce a divestiture after completion the M&A. Panel B of Appendix

A provides additional details on identification of M&A and non-M&A firms.

5. Research design

I employ a multinomial logit model to test my hypotheses. In a traditional logit model, the dependent variable has two outcomes and the output reports one column. This one column is the

20 comparison of one outcome (often, this dependent variable equals 1) versus the base outcome

(often, this dependent variable equals 0). A multinomial logit model is appropriate for a multi- outcome dependent variable. I use a multinomial logit rather than an ordered logit because the order is not clear. Prior literature has shown that firms tend to prefer spin-offs (Bergh 2017), but I do not know whether firms prefer to divest by sell-off or equity carve-out. The multinomial output reports a set of columns, one for each group except the base group. Each column provides the outcome of comparing a non-base group to the base group. I use the multinomial logit regression in Equation (1) to test H1:

P(div3 = 1, 2) = α + β post1 + γ Controls (1) P(div3 = 0)

I examine the influence of a financial reporting change on divestiture choice, which has three potential outcomes: divesting by spin-off, equity carve-out, or sell-off. My outcome variable is divestiture choice (div3). I set my base outcome to sell-offs (div3 = 0) because I hypothesize that firms decrease their selection of sell-offs after the reporting change. The output reports one column for spin-offs (div3 = 2) compared to sell-offs and a second column for equity carve-outs (div3 = 1) compared to sell-offs. My independent variable of interest is an indicator variable for divestitures that occur in the post-period (post1). The measurement of post1 benefits from the staggered adoption of the financial reporting change. Non-M&A firms adopted the reporting change in 2003, while M&A firms adopted the reporting change in 2009. Under a single adoption, another event that occurs at the same time could cause the effect found in the post-period. Under a staggered adoption, confounding events would need to occur at all the adoption times to do the same. The strength of the staggered adoption over a single adoption is that such events are much less likely to occur and explain the results.

21 I control for variables that influence management’s preferences among divestiture form, found by prior literature. Duhaime and Grant (1984) and Hoskisson, Johnson, and Moesel (1994) find that financial distress and low or underperformance drives firms to choose sell-offs over other forms of divestitures. To control for poor performance, I include an indicator variable if the firm reported negative net income for the fiscal year ended preceding the divestiture (ni_loss1). Bergh and Sharp (2015) find that firms are more likely to divest by spin-off when outside blockholders own more of the firm’s stock and when the divested unit is larger.16 To control for outside blockholder ownership, I include a variable bounded between 0 and 1 for percentage ownership by institutional investors (pih). I also control for the natural log of total assets (ln_at). Lang et al.

(1995) finds that firms that need cash to reduce their financial leverage prefer sell-offs and equity carve-outs over spin-offs. I measure leverage (lev) as debt divided by total assets, with debt defined as total liabilities, including preferred stock and excluding convertible debt (Yin and Ritter 2019).

All variables are described in detail in Appendix B. All continuous variables are winsorized at the

1% and 99% level.

6. Results

6.1 Descriptive statistics

Panel A of Table 2 provides descriptive statistics by divestiture form. My main variable of interest, post1, shows that sell-offs (mean = 0.457) and spin-offs (mean = 0.550) are relatively evenly distributed across the sample, with 45.7% of sell-offs and 55.0% of spin-offs occurring in the post-period. Equity carve-outs (mean = 0.275) are found primarily in the pre-period, with only

16 I still need to include a variable to control for characteristics of the divested unit. I considered transaction size but it is not well populated. I also considered the decrease in total assets from the quarter before the divestiture and the quarter of the divestiture from Compustat Fundq, but the measure would be very noisy.

22 27.5% of equity carve-outs occurring in the post-period. Institutional holdings are about 40-50% across all divestiture forms, with spin-offs having the highest percentage and equity carve-outs having the lowest. On average firms that divest through sell-offs are larger, whereas firms that divest through spin-offs are smaller. It is important to note that all firms in my sample are large, so the size comparisons among groups is relative. If a firm had negative net income, it is more likely to divest through a sell-off or equity carve-out, consistent with the financial- underperformance motive (Duhaime and Grant 1984). Firms with more M&A activity are more likely to divest by sell-off than by the other forms. Panel B of Table 2 provides descriptive statistics for the pre- and post-period. In the post-period, firms have higher institutional holders, greater total assets, and greater occurrence of negative net income preceding the divestiture. Leverage remains consistent between periods.

Table 3 presents correlation analyses. Selloff is 1 for sell-offs and 0 for equity carve-outs and spin-offs, eco is 1 for equity carve-outs and 0 for sell-offs and spin-offs, and spinoff is 1 for spin-offs and 0 for sell-offs and equity carve-outs. Correlation analyses, for the main variable of interest post1, show that in the post-period, firms are most likely to select spin-offs and least likely to select equity carve-outs. Firms that divest through a sell-off or equity carve-out have higher leverage and spin-off firms have lower leverage. Spin-off firms have fewer instance of a net loss preceding the divestiture and greater institutional holdings.

6.2 Main analyses

Table 4 presents the results of testing H1, depicted in Equation (1). Columns (1a) and (1b) provide base results. I add industry fixed effects in columns (2a) and (2b) and cluster by firm in addition to the fixed effects in columns (3a) and (3b). The base group is sell-offs, so (a) columns

23 show equity carve-outs compared to sell-offs, and (b) columns show spin-offs compared to sell- offs. Instead of presenting coefficients from the multinomial logit regression, I present the relative risk ratios (RRR). The RRR, obtained by exponentiating the multinomial logit coefficients ecoef, shows the likelihood of the outcome to be in the comparison relative to the base group as one independent variable changes, all else equal. For an RRR greater (less) than 1, as the independent variable increases, the likelihood of the comparison (base) outcome is greater.

When firms face mandatory delayed recognition of restructuring charges, they prefer to divest by spin-off, then by sell-off, and lastly by equity carve-out. The RRR for post1 in column

(3a) of 0.449 (p-value < 0.001, untabulated) shows that a one-unit increase in post1 (i.e., going from the pre-period to the post-period) decreases the relative risk of choosing equity carve-outs to sell-offs by a factor of 0.449. In other words, firms are more likely to choose sell-offs over equity carve-outs in the post-period compared to the pre-period. The RRR for post1 in column (3b) of

1.576 (p-value = 0.005, untabulated) shows that a one-unit increase in post1 increases the relative risk of choosing spin-offs to sell-offs by a factor of 1.576. Firms are more likely to choose spin- offs over sell-offs in the post-period. Ordinarily, inferences about the comparison between spin- offs and equity-carveouts for post1 cannot be made without setting one of them as the base group in another set of tests. However, because I find that spin-offs are more likely than sell-offs and sell-offs are more likely than equity carve-outs, I can infer that spin-offs are more likely than equity carve-outs by the transitive property of order (if A > B and B > C, then A > C).17

The spin-off preference is intuitive; the motives behind a spin-off are purely strategic and not driven by financial underperformance, so a spin-off is not impacted by the inability to take a

17 I check this inference by re-running the multinomial logit regression and setting the base to equity carve-outs and find that spin-offs are more likely than equity carve-outs to be chosen in the post-period by a factor of 3.330 (untabulated, p-value < 0.001).

24 “big bath” prior to the divestiture in the post-period. The preference for sell-offs above equity carve-outs is not immediately clear, but Figure 4 shows that the decrease in equity carve-out observations occurs around FAS 141, which disallowed the pooling-of-interests method. Control variables are consistent with prior literature. Firms with a loss preceding the divestiture are less likely to divest through a spin-off, and highly levered firms are more likely to divest through a sell-off.

6.3 Additional analyses

6.3.1 M&A firms vs non-M&A firms

In the main analyses, I assume that the reporting change creates a homogeneous response in the change in manager selection of divestiture form. This assumption implies that M&A firms and non-M&A firms change their divestiture selection similarly in response to the reporting change. However, these two groups could differ in their response to the reporting change. First, an

M&A is a significant transaction that increases the total size of the firm, potentially beyond efficiency (Jensen 1986). If an M&A firm seeks to only retain a portion of the M&A, the firm would likely sell off the unwanted portions of the M&A.18 Sell-off desirability to M&A firms likely holds through the reporting change. Therefore, I expect that M&A firms are less likely to drive the increase in selection of spin-offs.

Second, M&A firms experienced an additional relevant standard change in its pre-period.

In 2001, M&A firms were no longer allowed to use the pooling-of-interests method. Among other issues, the pooling method allowed the parent company to include all the performance of the target company in the financial statements, even if the M&A was initiated and completed on the last day

18 In untabulated tests, I find that sell-offs are the quickest form of divestiture (from announcement to effective date).

25 of the fiscal year. During the pooling period, firms substantially increased their M&A activity, which could have an effect on how firms divest. In addition, SAB 51 allowed firms to recognize gains on equity carve-outs in certain limited circumstances, but in practice, firms applied the

Securities and Exchange Commission (SEC) guidance very liberally and often recognized gains

(Briloff 1992). Therefore, I expect that the decline in desirability of equity carve-outs is likely due to the removal of the pooling-of-interests method and SAB 51 for M&A firms.

I use the multinomial logit regression in Equation (2) to conduct my additional analyses:

P(div3 = 1,2) = α + 훽 post1 + 훽 post1 ∗ MA + 훽 MA + 훽 pooling * MA + γ Controls (2) P(div3 = 0) 1 2 3 4

My independent variables of interest are post1, MA, and the interaction between the two.

Post1 is defined as before, and MA identifies firms that have an M&A in the year preceding the divestiture. The pooling variable is an indicator variable that equals 1 if the firm has a merger or acquisition in the year preceding the divestiture, and the M&A was before 2001. It extracts variation in the pre-period from when the pooling-of-interests method was allowed. Because the pooling-of-interests method only applies to M&A firms, I include the interaction between pooling and MA but not the pooling indicator on its own. Control variables are the same as in the main analyses.

Table 5 presents the results of the specification depicted in Equation (2). Columns (1a) and

(1b) present the base results. I cluster by firm in columns (2a) and (2b). I do not include industry fixed effects in this set of analyses due to the inclusion of the MA variable. Inclusion of both would induce multicollinearity. I maintain sell-offs as the base group.

In the pre-period, firms with an M&A are most likely to divest by sell-off (testing β3 = 0).

In untabulated results, I set the base to equity carve-outs and find that between spin-offs and equity carve-outs in the pre-period, M&A firms are more likely to spin-off. Thus, in the pre-period, M&A

26 firms prefer to divest by sell-off, then by spin-off, and last by equity carve-out compared to non-

M&A firms. In the post-period, firms with an M&A remain most likely to divest by sell-offs compared to non-M&A firms [testing β2 + β3 = 0; column (2a): RRR = 0.283, χ2-statistic = 6.47; column (2b): RRR = 0.226, χ2-statistic = 40.25].

M&A firms have no change in divestiture preference from the pre- to post-period (testing

β1 + β2, RRR = 1.520, χ2-statistic = 0.80; column (2b): RRR = 1.124, χ2-statistic = 0.23).19

Therefore, M&A firms maintain sell-offs as their most selected divestiture form. Non-M&A firms are more likely to divest by spin-offs and sell-offs in the post-period compared to the pre-period

(testing β1 = 0). The results from the main analyses show that in the post-period, the firms increase their selection of spin-offs and sell-offs by decreasing their selection of equity carve-outs. The results in Table 5 show that the selection of spin-offs is driven by the non-M&A firms and that both M&A and non-M&A firms select sell-offs over equity carve-outs.

Lastly, the results from the Pooling indicator variable show that some of the change in divestiture selection from the pre-period to the post-period can be attributed to M&A activity and divestiture accounting under the pooling-of-interests period (early pre-period). These financial reporting rules explain the prevalence of equity carve-outs in the pooling-of-interests period and the sharp decline after the rules changed.

19 Removing the pooling indicator variable changes only this result. In the first half of the pre-period, firms could account for M&As using the pooling-of-interests method, which allowed earnings management (“purchased” performance) through M&As. In this period, my results show that firms were most likely to divest through equity carve-outs (testing pooling = 0). From the non-pooling pre-period to the post-period, there is no change in M&A firms’ preference for equity carve-outs (testing MA + MA * post1 = 0, when the regression includes the pooling indicator). From the full pre-period to the post-period, M&A firms are less likely to divest through equity carve-outs because firms were only likely to divest more through equity carve-outs in the pre-period during the pooling time period (untabulated; testing MA + MA * post1 = 0, when the regression excludes the pooling indicator). Firms using the pooling-of-interests method likely divested through equity carve-outs in order to keep the purchased performance on the books. A sell-off or spin-off could remove the divested performance. This finding provides additional evidence that financial reporting can influence divestiture choice.

27 6.3.2 Mechanism of change in selection of divestiture form

In the main analyses, I test whether a change in financial reporting for restructuring influences selection of divestiture form from the pre-period to the post-period in order to first document the main effect. In the hypothesis development, I posit that the decline in earnings management opportunities more likely influences financially underperforming firms than it does strategic firms. However, I did not provide evidence in the main analyses of this underperformance mechanism. In this additional analysis, I expect that the shift in selection of spin-offs over sell-offs is more pronounced for financially underperforming firms.

I use the multinomial logit model regressions in Equations (3) and (4) to conduct my additional analyses:

P(div3 = 1,2) = α + 훽 post1 + 훽 post1 ∗ ni_loss1 + 훽 ni_loss1 + γ Controls (3) P(div3 = 0) 1 2 3

P(div3 = 1,2) = α + 훽 post1 + 훽 post1 ∗ lev + 훽 lev + γ Controls (4) P(div3 = 0) 1 2 3

In Equation (3), my independent variables of interest are post1, ni_loss1, and the interaction between the two. In Equation (4), my independent variables of interest are post1, lev, and the interaction between the two. All variables are defined the same as before with an introduction of an interaction term. Because I expect the main effect to be stronger for financially underperforming firm, I include the interaction between post1 and ni_loss1 in one specification and the interaction between post1 and lev in the second specification. Based on prior literature, loss or high leverage firms are categorized as financially underperforming firms (Duhaime and

Grant 1984; Lang et al. 1995). Control variables are the same as in the main analyses.

Table 6 presents the results of the specifications depicted in Equations (3) and (4). Columns

(1a) and (1b) present the results for Equation (3), and columns (2a) and (2b) present the results for

28 Equation (4). I include Fama-French 12-industry classification fixed effects and cluster by firm in both specifications. I maintain sell-offs as the base group.

Focusing on column (1b) for selection of spin-off vs. sell-off, I find that non-financially underperforming firms (arguably, strategic firms) increase their selection of spin-offs compared to sell-offs from the pre- to post-period (testing β1 = 0). I find no statistically significant change for financially underperforming firms (testing β1 + β2, RRR = 1.246, χ2-statistic = 0.35) but I find that in the post-period, financially underperforming firms are more likely to select sell-offs over spin- offs compared to strategic firms (testing β2 + β3, RRR = 0.543, χ2-statistic = 3.56). Similarly, by focusing on column (2b), I find that lower leverage firms (arguably, strategic firms) increase their selection of spin-offs compared to sell-offs from the pre-period to the post-period (testing β1 = 0).

Again, I find no statistically significant change for higher leverage firms (testing β1 + β2, RRR =

0.614, χ2-statistic = 1.60), but I find that in the post-period, higher leverage firms are more likely to select sell-offs over spin-offs compared to strategic firms (testing β2 + β3, RRR = 0.389, χ2- statistic = 6.40).

The results from the main analyses show that in the post-period, the firms increase their selection of spin-offs by decreasing their selection of sell-offs. The results in Table 6 show that the increase in selection of spin-offs is driven by the strategic firms, defined as firms that have lower leverage or firms that did not recently experience a financial loss. A plausible explanation is that financially underperforming firms may no longer find divesting through a sell-off to be as profitable in the post-period as they once did in the pre-period. These firms may wait until strategic motives strengthen, thus becoming strategic firms, before divesting. More investigation is required before drawing any conclusions.

29 6.4 Robustness tests

In the main analyses, I categorize M&A firms as those that have at least one M&A in the year preceding the divestiture. The results are robust to categorizing M&A firms as those that have at least one M&A in the two years preceding the divestiture (post2). In the main analyses, I define financial underperformance as a net loss in the year preceding the divestiture. The results are robust to controlling for Altman’s Z-score (altmanz), a net loss in the two years preceding the divestiture

(ni_loss2), loss before extraordinary items in the year preceding the divestiture (ib_loss1), and a loss before extraordinary items in the two years preceding the divestiture (ib_loss2) instead.

7. Conclusion

This study examines how financial reporting of restructuring charges may affect choice of divestiture form. Academics have long studied the role of financial reporting in investment decisions; however, the role of financial reporting in divestiture decisions has received little to no attention. To investigate this issue, I use a hand-collected dataset of all forms of divestitures for publicly-traded firms from 1995 to present. Identification and examination of spin-offs, equity carve-outs, split-offs, and spin-offs answers Bergh’s (2017) call for more research involving multiple or all forms of divestitures. I use this database to investigate changes in firms’ divestiture form choice after the accounting change for restructuring charges: financial standards in the pre- period permit acceleration of restructuring charge recognition, while financial standards in the post-period require recognition when the charges are incurred. The delay in recognition of restructuring charges reduces firms’ ability to manage earnings through a “big bath.” Fewer earnings management opportunities in the post-period weakens the financial-underperformance motive in selecting divestiture form and thus reduces the desirability of sell-offs, the primary

30 vehicle of financial-underperformance divestitures. I expect and find that firms will increase their selection of spin-offs as their divestiture form in the post-period.

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34 Figure 1 Summary of forms of divestitures

Divestiture Sell-off Equity carve-out Spin-off form div3 = 0 div3 = 1 div3 = 2 Ownership Previous owners Parent company Previous owners maintain same maintains some own both spinnor ownership (only ownership in (original) and an asset/line is subsidiary; new spinnee (new) sold) investors own part of subsidiary Control Previous owners Parent company Spinnor and maintain same and new outside spinnee are control investors control separate entities; the subsidiary previous owners have same level of control in each Cash involved? Yes Yes No Income Recognize May have gain or Expense spin-off statement gain/loss; loss, depending costs; discretion effect? potentially on type of shares in continuing discontinued (primary or and/or operations secondary) or loss discontinued of control operations Accounting Sale Equity transaction Typically, pro rata (current) distribution (or assign value according to underlying economics) at recorded amount Accounting Not in APB 29 history codification (the superseded by (summarized, word "carve" is Codification in 20 years) nowhere to be 2009 (ASC 845 found) and 505-60, codified without major changes)

35 Figure 2 Timelines of expense recognition across the divestiture process

Panel A: Restructuring charge recognition in the pre-period (EITF 94-3 and EITF 95-3)

Record restructuring expenses and liabilities

Identification Restructuring Restructuring of number of Restructuring Divestiture plan costs factory costs complete commitment incurred: workers to incurred: (e.g. date or M&A termination terminate closure of effective completion of factory and factories factory date) date employees to close

Panel B: Restructuring expense recognition in the post-period (FAS 146 and FAS 141(R))

Record restructuring expenses and liabilities

Identification Restructuring Restructuring of number of Restructuring Divestiture plan costs factory costs complete commitment incurred: workers to incurred: (e.g. date or M&A termination terminate closure of effective completion of factory and factories factory date) date employees to close

Note: In the pre-period, firms must follow EITF 94-3 or EITF 95-3, which allow recording restructuring charges starting at the restructuring plan commitment date or M&A completion date. In the post-period, firms must follow FAS 146 or FAS 141(R), which require recording expenses when they are incurred, or when actual restructuring charges are complete. Firms started recording restructuring charges later in the divestiture process in the post-period compared to the pre-period.

36 Figure 3 Timeline of accounting rules for restructuring

1995 2002 2007 Present

Pre-period Post-period

FAS 141(R) M&A-related ______Recognize exit costs ______restructuring when incurred (delay expense recognition)

Pre-period Post-period

FAS 146 Non-M&A-related ______Recognize exit costs ______restructuring when incurred (delay expense recognition)

Note: The accounting rules governing the pre-periods (EITF 95-3 and EITF 94-3) allowed exit costs to be recognized before incurred: EITF 95-3 allowed exit (restructuring) costs related to an M&A to be recognized as soon as the acquisition is complete, and EITF 94-3 allowed exit costs unrelated to an M&A to be recognized starting at the plan commitment date. FAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The post period is 2010 (2011) and after for firms with divestitures and an acquisition or business combination one (two) years preceding the divestiture. FAS 146 is effective for exit or disposal activities initiated after December 31, 2002. The post-period is 2003 and after for divestitures not associated with an acquisition or business combination.

37 Figure 4 Frequency of divestitures across time

Panel A: Frequency of sell-offs

Panel B: Frequency of equity carve-outs

38 Panel C: Frequency of spin-offs

39 Appendix A Details of data collection

Panel A: Identification of divestitures

I can identify all forms of divestitures through either SDC Platinum or SEC filings. Textual analysis of SEC filings is a noisy identification method, unless paired with hand collection. However, SDC places restrictions on identification of different forms of divestitures. To include as many divestitures possible, I start with SDC to determine how to identify divestitures using SEC filings, use word-search textual analysis of SEC filings, and then manually go through the filings to ensure the accuracy of identification.

Identification of sell-offs The SDC M&A definition of a “divestiture” is a loss of majority control, loss a majority interest in the target, or target company disposal of assets. I include the sell-off if the seller nation or seller ultimate parent nation is USA. I manually inspected 20 random gvkeys to determine whether these “divestitures” also identify spin-offs, equity carve-outs, or split-offs. A “divestiture” did not occur in the same year for any of these gvkeys as a spin-off, equity carve-out, or split-off. I will use this information to investigate expanding the sample later. The challenge is to identify how firms identify sell-offs in their SEC filings.

Identification of split-offs The SDC M&A definition of a split-off is the parent owns 100% before and 0% after (high identification restriction). Using the 27 split-offs from SDC, I found that the SEC filings for split- offs were filed using Forms 8-K, SC 13E4, SC TO-I, 425, SC 13D, SC 13D/A, S-1, S-3, or S-4. Keywords: are split-off ("splitoff", "split-off", "split off") and/or exchange (“exchange offer” “tax- free exchange” “share exchange” “exchange of share”). I remove filings with zero of both keyword types, and remove if the “split-off” keyword set is mentioned less than two times. I first sort filings by cik then filing date then read through the filings to identify the first date a split-off is mentioned by either the parent or the subsidiary.

Identification of spin-offs The SDC M&A definition of a spin-off is a distribution to shareholders with no regard to percentage owned before or after (no identification restriction). All spinnees (spin-off subsidiary) must file Form 10-12B with the SEC. I read each Form 10-12B to identify if it is an actual spin- off and match to the parent company. Most of the time, the parent information is in EX 99.1, the information statement. Without EX 99.1, the filing is sometimes a regular registration, not a spin- off filing. In addition, some filings are actually a Form 12b-25 Notification of Late Filing or securities to be registered under Form 10-12G rather than Form 10-12B; I remove these filings. Of the 366 spin-offs originally identified, 325 (88.8%) were in the SDC M&A database.

Identification of equity carve-outs The SDC Global New Issues (do not use M&A) definition of an equity carve-out is a distribution or sale of shares to the public via an IPO, only if they represent 100% of the unit, subsidiary division or other company (high restriction). In Global New Issues, I include all equity but not preferred stock (debt section), and then in the second window include common or ordinary shares

40 (exclude preferred stock or debt issues). I require the parent nation to be the USA and the IPO flag to be “YES.”

Of 1,037 equity carve-outs identified in SDC, I then match to Compustat Funda and require an SEC filing. The carve-out entity and/or parent can file the carve-out. Carve-out filings include Forms S-1 (most common), S-1/A, S-3, S-11, 424B4, 10-Q, 8-K, N-2, or SB-2. Parents filings include 10-K, 10-Q, or 8-K. Keywords are “(parent name)” or “selling s(hareholder takeholder)” or “principal s(hareholder takeholder).” I use the earlier date of the carve-out and parent filings. I will use this information to expand the sample later. There are too many carve-out and parent filings to review at this time.

Data limitation I can only identify and obtain control variable information for public parents or principal/selling shareholders.

Combining divestitures Ex-ante differences: • Accounting: Spin-offs and split-ups are distributions. Equity carve-outs are equity transactions. Split-offs and sell-offs are sales. • Ownership: Spin-offs and split-ups have the same ownership percentages for both parent and subsidiary. In sell-offs and split-offs, owners lose part of the company. Equity carve- outs introduce new investors. • Control: Spin-offs and split-ups maintain the same owners and same control levels. Split- offs and sell-offs reduce the control span through a reduction in company size. In an equity carve-out, original owners have a diluted vote.

Ex-post resolution: • Many companies change their names after a spin-off. I suspect those instances are split- ups. Prior literature includes both split-ups and spin-offs together and calls them spin-offs, which may not matter depending on the research question. For my purposes, I combine them anyway. I could not find prior literature on how to identify split-ups and did not see any ways to identify them in SDC, so I looked at a few split-ups in the news and went to SEC filings to determine how to identify them: o DowDuPont split up into three companies, but filing-wise, they spin off two parts of the company.20 o Anecdotal SEC analysis: “This was the case in 2015, when Hewlett-Packard split into two independent firms, and in 2016, when Yahoo spun off Alibaba. Some of these actions reach into the billions of dollars: eBay’s spin-off of PayPal was valued at $49.16 billion in July 2015, and the two companies’ market values were recently assessed at approximately $33 billion and $45 billion, respectively” (Bergh 2017). Conceptually, Hewlett Packard split up into HP Inc. and Hewlett-Packard

20 https://www.morningstar.com/news/dow-jones/TDJNDN_201902011949/dowdupont-sales-are-flat-ahead-of- planned-splitup-wsj.print.html

41 Enterprise. However, in practice, Hewlett Packard spun off HP Enterprise and then changed its name to HP.21 • Split-offs are pretty rare, so it works out to lump them with another divestiture form anyway: the sell-offs. I investigate the data to see whether firms have both sell-offs and split-offs in the same year. Only one firm-year with both – I combine them into one firm- year of div3 = 0.

Panel B: Identification of M&A

I use SDC M&A data to proxy for whether a divestiture is “associated with acquisitions and business combinations.” I begin with US and non-US targets in the first filter. First, I require the acquirer nation to be the US in the second filter and download 1995-2018 in 3-year increments (download size limited). Second, I require the target nation to be in the US and download 1995- 2018 in 3-year increments (in a merger, the “target” can be one of the merging firms).

I then merge the SDC data to Compustat on cusip (if either the parent or the target match) and within 365 days (or 2 years) preceding a divestiture in that firm-year. Thus, the M&A occurred over that fiscal year. By firm-year, I count the number of deals to create an indicator variable if the number of deals is greater than 0 (whether M&A occurred in the year or two preceding a divestiture).

FAS 146 is effective for exit or disposal activities initiated after December 31, 2002. FAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An assumption is required because it is difficult to know when is (1) the exact initiation of exit or disposal activities and (2) the exact acquisition “date” occur (assume effective date is the acquisition date). For FAS 146, I assume the pre-period is 1995-2002 and the post-period is 2003- 2019 for divestitures. For FAS 141(R), I assume the pre-period is 1995-2008 and the post-period is 2009-2019 for the M&A. If there is no M&A in that fiscal year, the pre-period is 1995-2002 and the post-period is 2003-2019 for both 1-year and 2-year non-M&A years. If there is an M&A, the pre-period is 1995-2009 (to allow one year for the M&A to occur before the divestiture) and the post-period is 2010-2019. In a robustness test, if there is an M&A, the pre-period is 1995-2010 (to allow two years for the M&A to occur before the divestiture) and the post-period is 2011-2019.

Limitation: It is difficult to determine whether associated or not, assume if it is within a year (or two) then it is associated.

21 http://fortune.com/2015/07/01/hewlett-packard-filing-split/

42 Appendix B Variable definitions

Variable Definition div3 = 0 for sell-offs and split-offs; 1 for equity carve-outs; 2 for spin-offs. post1 = 1 if (1) the firm had an M&A announcement within a year preceding a divestiture in 2010 or later [allow M&A to occur in 2009] or (2) the firm had zero M&A announcements preceding a divestiture in 2003 or later; 0 otherwise. See Figure 3. post2 = 1 if (1) the firm had an M&A announcement within a year preceding a divestiture in 2011 or later [allow M&A to occur in 2009-2010] or (2) the firm had zero M&A announcements preceding a divestiture in 2003 or later; 0 otherwise. See Figure 3. ni_loss1 = 1 if the firm reported negative net income for the fiscal year ended preceding the divestiture; 0 otherwise. ni_loss2 = 1 if the firm reported negative net income for either of the two fiscal years ended preceding the divestiture; 0 otherwise. ib_loss1 = 1 if the firm reported negative income before extraordinary items for the fiscal year ended preceding the divestiture; 0 otherwise. ib_loss2 = 1 if the firm reported negative income before extraordinary items for either of the two fiscal years ended preceding the divestiture; 0 otherwise. altmanz = Altman's Z-score Working capital Retained earnings Earnings before interest and taxes = 1.2 + 1.4 + 3.3 Total assets Total assets Total assets Market value of equity Sales + 0.6 + 0.999 , Book value of debt Total assets a measure of financial distress (Altman, 1968a). pih = total percentage holdings of institutional investors (13-F SEC filings). ln_at = natural log of total assets from the fiscal year ending preceding the firm's divestiture. lev = debt / total assets. Debt is defined as total liabilities, minus convertible debt, plus preferred stock (Yin and Ritter 2019). div_count = number of divestitures for that firm-year's divestiture form. merg_acq = number of M&A announcements within the year preceding the firm's divestiture. MA = 1 if the firm has a merger or acquisition in the year preceding the divestiture. pooling = if the firm has a merger or acquisition in the year preceding the divestiture, and the M&A was before 2001.

43 Table 1 Sample selection

Panel A: Sample selection Combined (div3 = 0) Equity carve-out Spin-off Sell-off Split-off (div3 = 1) (div3 = 2) Total

Divestiture flag in firm-years in which firms have at least 10 million in lagged total assets 369 103 150 334 956

Combine sell-off and split-off (loss of one; one firm-year with a split-off and a sell-off) 471 150 334 955

Delete if missing control (3) (1) (1) (5) variables 468 149 333 950

Panel B: Divestiture form by period post1 = 0 post1 = 1 Total Sell-offs and split-offs (div3 = 0) 254 214 468 Equity carve-outs (div3 = 1) 108 41 149 Spin-offs (div3 = 2) 150 183 333 Total 512 438 951

44 Table 2 Descriptive statistics

Panel A: Descriptive statistics by divestiture form

Variable N Mean StdDev P25 P50 P75 Sell-off post1 468 0.457 (div3 = 0) pih 468 0.443 0.350 0.004 0.514 0.743 at 468 153,147 356,432 1,542 12,195 57,953 ni_loss1 468 0.224 div_count 468 1.122 0.393 1 1 1 merg_acq 468 7.795 17.847 1 2 7 lev 468 0.696 0.331 0.512 0.683 0.893 Equity carve- post1 149 0.275 out pih 149 0.418 0.327 0.025 0.475 0.693 (div3 = 1) at 149 65,662 283,224 315 2,511 15,462 ni_loss1 149 0.215 div_count 149 1.101 0.415 1 1 1 merg_acq 149 4.168 10.752 0 1 3 lev 149 0.582 0.260 0.373 0.581 0.774 Spin-off post1 333 0.550 (div3 = 2) pih 333 0.494 0.362 0.021 0.596 0.809 at 333 22,513 83,152 1,766 5,361 19,340 ni_loss1 333 0.162 div_count 333 1.069 0.287 1 1 1 merg_acq 333 2.769 10.926 0 0 3 lev 333 0.606 0.244 0.463 0.611 0.742

Panel B: Descriptive statistics by pre- and post-period

Variable N Mean StdDev P25 P50 P75 Pre-period pih 512 0.431 0.325 0.013 0.500 0.700 (post1 = 0) at_lag 512 79,600 254,714 1,023 3,786 25,218 ni_loss1 512 0.174 div_count 512 1.098 0.357 1 1 1 merg_acq 512 6.162 16.523 0 2 6 lev 512 0.644 0.267 0.481 0.650 0.815 Post-period pih 438 0.487 0.379 0.006 0.608 0.825 (post1 = 1) at_lag 438 110,042 315,807 2,387 9,506 35,569 ni_loss1 438 0.233 div_count 438 1.103 0.372 1 1 1 merg_acq 438 4.648 12.716 0 1 3 lev 438 0.649 0.327 0.451 0.622 0.804

Note: Variable definitions in Appendix A.

45 Table 3 Correlation analyses

selloff eco spinoff post1 ni_loss1 pih ln_at lev selloff -0.425 -0.724 -0.007 0.057 -0.061 0.176 0.176 eco -0.425 -0.317 -0.161 0.015 -0.056 -0.149 -0.094 spinoff -0.724 -0.317 0.130 -0.071 0.107 -0.070 -0.113 post1 -0.007 -0.161 0.130 0.073 0.113 0.132 -0.029 ni_loss1 0.057 0.015 -0.071 0.073 -0.154 -0.321 0.024 pih -0.040 -0.048 0.078 0.081 -0.155 0.236 -0.066 ln_at 0.106 -0.115 -0.023 0.050 -0.376 0.276 0.368 lev 0.165 -0.095 -0.101 0.008 0.079 -0.101 0.143

Note: Selloff = 1 for sell-off firm-years and 0 for equity carve-out or spin-off firm-years. Eco = 1 for equity carve-out firm years and 0 for sell-off or spin-off firm-years. Spinoff = 1 for spin-off firm-years and 0 for sell-off or equity carve- out firm-years. All other variables are defined in Appendix B. Pearson correlation coefficients presented below the diagonal, and Spearman correlation coefficients presented above the diagonal. Correlation coefficients are bolded if significant at the 5% level.

46 Table 4 Main analyses: Change in selection of divestiture form

(1a) (1b) (2a) (2b) (3a) (3b) div3 = 1 div3 = 2 div3 = 1 div3 = 2 div3 = 1 div3 = 2 Equity Spin-off Equity Spin-off Equity Spin-off vs. carve-out vs. sell-off carve-out vs. sell-off carve-out sell-off vs. sell-off vs. sell-off vs. sell-off post1 0.466*** 1.510*** 0.449*** 1.576*** 0.449*** 1.576*** (-3.63) (2.78) (-3.67) (2.96) (-3.31) (2.83) ni_loss1 0.777 0.558*** 0.745 0.622*** 0.745 0.622*** (-0.98) (-2.79) (-1.10) (-2.23) (-1.10) (-2.03) pih 1.001 1.485* 1.115 1.342 1.115 1.342 (0.03) (1.80) (0.36) (1.30) (0.36) (1.21) ln_at 0.883*** 0.918*** 0.877*** 0.955 0.877*** 0.955 (-3.15) (-2.89) (-3.14) (-1.39) (-3.09) (-1.20) lev 0.325*** 0.421*** 0.356*** 0.444*** 0.356*** 0.444*** (-3.16) (-3.24) (-2.95) (-2.91) (-3.27) (-2.84) Constant 2.555** 1.983** 2.351 2.308* 2.351 2.308* (2.51) (2.26) (1.44) (1.90) (1.34) (1.61)

Fixed effects No No FF12 FF12 FF12 FF12 Clustering No No No No Firm Firm Observations 950 950 950 950 950 950 Wald χ2 82.51 82.51 143.6 143.6 131.4 131.4

Notes: In a multinomial logit model, the base group is a combination of sell-offs and split-offs (div3 = 0). Columns (1a), (2a), and (3a) contain comparisons of equity carve-outs (div3 = 1) and the base. Columns (1b), (2b), and (3b) contain comparisons of spin-offs (div3 = 2) and the base. See Appendix A for variable definitions. Columns (1a) and (1b) contain controls from prior literature. Columns (2a) and (2b) incrementally include industry fixed effects, and Columns (3a) and (3b) incrementally include clustering by firm. Relative risk ratio for each coefficient presented with z-statistics in parentheses. *** indicate a p < 0.01, ** for p < 0.05, and * for p < 0.1.

47 Table 5 Additional analyses: M&A firms vs. non-M&A firms

(1a) (1b) (2a) (2b) div3 = 1 div3 = 2 div3 = 1 div3 = 2 Equity Spin-off Equity Spin-off vs. carve-out vs. sell-off carve-out sell-off vs. sell-off vs. sell-off

post1 0.260*** 0.867 0.260*** 0.867 (-4.06) (-0.53) (-3.47) (-0.54) MA * post1 5.835*** 1.296 5.835*** 1.296 (3.12) (0.73) (2.80) (0.71) MA 0.049*** 0.174*** 0.049*** 0.174*** (-6.79) (-6.00) (-6.92) (-5.95) MA * pooling 7.664*** 0.989 7.664*** 0.989 (4.99) (-0.04) (5.15) (-0.04) ni_loss1 1.072 0.642 1.072 0.642 (0.26) (-2.00) (0.26) (-1.81) pih 1.574 2.302*** 1.574 2.302*** (1.41) (3.49) (1.34) (3.24) ln_at 0.971 0.990 0.971 0.990 (-0.66) (-0.32) (-0.61) (-0.29) lev 0.314*** 0.429*** 0.314*** 0.429*** (-3.03) (-3.01) (-3.26) (-2.97) Constant 3.029*** 2.962*** 3.029*** 2.962*** (2.64) (3.12) (2.31) (2.89)

Fixed effects No No No No Clustering No No Firm Firm Observations 950 950 950 950 Wald χ2 216.5 216.5 179.5 179.5

Notes: In a multinomial logit model, the base group is a combination of sell-offs and split-offs (div3 = 0). Columns (1a) and (2a) contain comparisons of equity carve-outs (div3 = 1) and the base. Columns (1b) and (2b) contain comparisons of spin-offs (div3 = 2) and the base. See Appendix A for variable definitions. Columns (1a) and (1b) contain controls from prior literature, plus an indicator variable for whether the pooling-of-interests method is allowed (to pull out the effect in the pre-period from the pooling-of-interests method of accounting). Columns (2a) and (2b) incrementally include clustering by firm. Relative risk ratio for each coefficient presented with z-statistics in parentheses. *** indicate a p < 0.01, ** for p < 0.05, and * for p < 0.1.

48 Table 6 Additional analyses: Mechanism of change in selection of divestiture form

(1a) (1b) (2a) (2b) var = ni_loss1 var = lev div3 = 1 div3 = 2 div3 = 1 div3 = 2 Equity Spin-off Equity Spin-off carve-out vs. sell-off carve-out vs. sell-off vs. sell-off vs. sell-off

post1 0.460*** 1.665*** 0.279*** 1.962* (-2.89) (2.85) (-2.77) (1.65) post1 * var 0.895 0.748 2.204 0.699 (-0.21) (-0.70) (1.18) (-0.63) var 0.784 0.726 0.247*** 0.556 (-0.76) (-1.08) (-2.70) (-1.33) ni_loss1 0.763 0.618** (-1.01) (-2.04) pih 1.110 1.329 1.102 1.350 (0.34) (1.16) (0.32) (1.22) ln_at 0.877*** 0.952 0.885*** 0.955 (-3.07) (-1.27) (-2.82) (-1.19) lev 0.357*** 0.449*** (-3.24) (-2.82) Constant 0.850 0.830 1.004 0.703 (1.33) (1.60) (1.54) (1.29)

Fixed effects FF12 FF12 FF12 FF12 Clustering Firm Firm Firm Firm Observations 950 950 950 950 Wald χ2 134 134 136.5 136.5

Notes: In a multinomial logit model, the base group is a combination of sell-offs and split-offs (div3 = 0). Columns (1a) and (2a) contain comparisons of equity carve-outs (div3 = 1) and the base. Columns (1b) and (2b) contain comparisons of spin-offs (div3 = 2) and the base. See Appendix A for variable definitions. Columns (1a) and (1b) interact post1 with ni_loss1, and Columns (2a) and (2b) interact post1 with lev. Relative risk ratio for each coefficient presented with z-statistics in parentheses. *** indicate a p < 0.01, ** for p < 0.05, and * for p < 0.1.

49