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2023 Feb/23
Spin-off and Treasury Stock Magic
Issue Papers 23-06
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- Research Topic Capital Markets
- Page 21
- Summary
- The so-called treasury stock magic refers to the phenomenon where a controlling shareholder gains stronger control over a new firm without additional investment. Assume that a parent firm pushing for a spin-off holds treasury stocks. In that case, the parent firm may regard itself as a shareholder and allocate new shares of the spin-off firm, which means the existing shareholder's control over the spin-off firm increases proportionally to the allocated stake. As the treasury stock magic increases the control of the controlling shareholder in the parent firm using its own treasury stocks, it has often been persistently condemned as an infringement of the interest of external shareholders.
This article shed light on the structure of spin-offs based on the treasury stock magic and carried out an empirical analysis on this issue in real-world practices. A model adopted for the treasury stock magic found that the combination of the treasury stock magic and investment in kind not only maximizes the control of controlling shareholders, but also effectively helps the controlling shareholder to meet the holding company requirements. Furthermore, controlling shareholders' control rises with a larger share of stake in treasury stocks, a higher spin-off ratio, and a spin-off firm's higher valuation relative to the parent firm. The data on a total of 144 spin-off cases in listed firms in Korea between 2000 and 2021 revealed that the firms transforming into holding companies extensively used the treasury stock magic in combination with capital increase via investment in kind. Also, those firms were found to have a higher stake in treasury stocks, a higher spin-off ratio, and a spin-off firm with higher valuation. As a result, spin-offs were found to lead to an evident increase in control of controlling shareholders, while cutting external shareholders' stake in market cap by 8.8 percentage points. On the other hand, no evident change was observed before and after spin-offs with regards to the ownership structure and shareholder composition of the firms that did not convert to holding companies.
The treasury stock magic is highly controversial due to its potential distortion of corporate control and wealth allocation. But this practice has persisted apparently under the current regulatory framework that lacks consistency in treating the actual economic value of treasury stocks. Although treasury stocks should not be viewed as holding economic value, quite a few laws and precedents recognize those stocks' asset-like features. This provides a rationale for new share allotment to treasury share holdings. What's needed at the current stage is a measure that could rein in the abuse of treasury stocks by controlling shareholders. More fundamentally, regulators must come up with a renewed regulatory scheme that better reflects the actual economic value of treasury stocks.