Deciding on Transaction Type  629 Carve-Outs  If parent companies do not want to give up control over a busi- ness unit immediately, they can consider carving out a minority ownership stake through an IPO. Another reason to consider a carve-out is that the parent needs cash for an acquisition or recapitalization. Carve-outs were popular in the late 1990s during the boom in the telecom, media, and technology (TMT) sector. Since then the allure of carve-outs has faded, with the need for cash propelling most decisions to pursue one. In the United States, the number of carve-outs has averaged about three to four per year since 2001, compared with about 15 to 20 per year during the TMT boom. When thinking about partially separating ownership of a business unit through a carve-out, executives should plan for full separation and indepen- dence. The separated businesses should be able to attract new equity financ- ing to fund their growth or perhaps pursuit of acquisitions, both of which will most likely dilute the parent’s stake, ultimately leading to loss of control. Carve-outs produce real benefits only if they achieve real independence from the parent company. The arc toward independence should be clear from the start. For example, Philips publicly committed to gradually selling down its remaining stake in its lighting business (Signify) after the IPO of that business in 2016. In September 2019, Philips sold its last remaining shares in Signify. In our research on more than 200 transactions completed in the carve-out boom of the 1990s, the majority of the carve-out entities did not last.22 As shown in Exhibit 32.5, only 8 percent of the carve-out subsidiaries analyzed Exhibit 32.5  Typical Carve-Out Trajectories % Parent stake Majority stake Controlling interest Trajectory of carve-outs completed before 1999 8 8 3 100 31 39 11 All carve-outs Independent (free float > 75%) Merged/ acquired Reacquisition Delisted Parent-controlled (free float < 75%) Median market- adjusted return, % 26 –17 –32 –17 Source: Datastream; Factiva. 22 A. Annema, W. Fallon, and M. Goedhart, “Do Carve-Outs Make Sense?,” McKinsey on Finance (Fall 2001): 6–10. 630  Divestitures remained majority-controlled by the parent. Only the carve-outs that gained independence from the parent delivered positive returns to shareholders. Those that were reacquired or remained parent-controlled showed negative shareholder returns. Academic research has found similar results.23 The mar- ket-adjusted long-term performance for carve-outs on average was negative, but different types of carve-outs differed significantly in their performance. Carve-outs from financially distressed parents showed negative returns and continue to have relatively low operating performance, indicating that they were partly contributing to the distress. Market performance appears to be better for carve-out transactions that improve the focus of both entities. Some publications also suggest a clear relationship between carve-out subsidiaries’ success in the capital markets and the evolution of their ownership structure, similar to our results in Exhibit 32.5.24 If the parent company retains a controlling stake, this can lead to gover- nance conflicts in the longer term. For example, enforcing a minimum con- trolling stake may restrict (acquisition) growth and value creation by the separated business, which would destroy the benefits that the carve-out was intended to deliver. Tracking Stock  An alternative form of public ownership restructuring is the issuance of tracking stock. Tracking stock offers a parent the advantage of maintaining control over a separated subsidiary, but it often complicates corporate governance. Because there is no formal, legal separation between the subsidiary and the parent, a single board of directors needs to decide on potentially competing needs of common and tracking stock shareholders. In addition to producing competing needs, tracking stocks also result in both entities being liable for each other’s debt, which precludes flexible capital raising. Although there may be specific tax or legal barriers in the way of sepa- ration that would favor the use of a tracking stock alternative, the evidence for tracking stock is far from convincing. In an analysis of tracking stocks, this kind of transaction appeared to destroy value in the long term.25 On the elimi- nation of tracking stock, the announcement effect for the parent was positive, reflecting the market’s relief that the structure had been discontinued. 23 See, for example, J. Madura and T. Nixon, “The Long-Term Performance of Parent and Units Following Equity Carve-Outs,” Applied Financial Economics 12 (2002): 171–181; and A. Vijh, “Long-Term Returns from Equity Carveouts,” Journal of Financial Economics 51 (1999): 273–308. 24 A. Klein, J. Rosenfeld, and W. Beranek, “The Two Stages of an Equity Carve-Out and the Price Response of Parent and Subsidiary Stock,” Managerial and Decision Economics 12 (1991): 449–460; K. Gleason, J. Madura, and A. K. Pennathur, “Valuation and Performance of Reacquisitions Following Eq- uity Carve-Outs,” Financial Review 41 (2006): 229–246; and M. Otsubo, “Gains from Equity Carve-Outs and Subsequent Events,” Journal of Business Research 62 (2008): 1207–1213. 25 M. Billett and A. Vijh, “The Wealth Effects of Tracking Stock Restructurings,” Journal of Financial Research 27 (2004): 559–583.