1.

What are the advantages and disadvantages of tracking or target stocks to investors and to the
firm?

Answer: The purpose in creating tracking stock is to enable the financial markets to value the
different operations within a corporation based on their own performance. Tracking or targeted
stocks provide the parent company with an alternative means of raising capital for a specific
operation by selling a portion of the stock to the public and an alternative ‘‘currency’’ for
making acquisitions. In addition, stock-based incentive programs to attract and retain key
managers can be implemented for each operation with its own tracking stock. Although tracking
stocks may not be created initially for the purpose of exiting a business, they make such a move
easier for the parent at a later date. Tracking stocks may create internal operating conflicts
among the parent’s business units. Such conflicts arise in determining how the parent’s
overhead expenses will be allocated to the business units and what price one business unit is
paid for selling products to other business units. In addition to creating internal problems,
tracking stocks can stimulate shareholder lawsuits. Although the unit for which a tracking stock
has been created may be largely autonomous, the potential for conflict of interest is substantial,
because the parent’s board and the target stock’s board are the same. The parent’s board
approves overall operating unit and capital budgets. Decisions made in support of one operating
unit may appear to be unfair to those holding a tracking stock in another unit. Thus, tracking
stocks can pit classes of shareholders against one another and lead to lawsuits.
2. What factors influence a parent firm’s decision to undertake a spin-off rather than a
divestiture or equity carve-out?

Answer: The decision as to which of these three strategies to use is often heavily influenced by
the parent firm’s need for cash, the degree of synergy between the business to be divested or
spun-off and the parent’s other operating units, and the potential selling price of the division.
However, these factors are not independent. Parent firms needing cash are more likely to divest
or engage in an equity carve-out for operations exhibiting high selling prices relative to their
synergy value. Parent firms not needing cash are more likely to spin-off units exhibiting low
selling prices and synergy with the parent. Parent firms with moderate cash needs are likely to
engage in equity carve-outs when the unit’s selling price is low relative to perceived synergy.