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RFS Advance Access originally published online on August 11, 2003
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Right arrow G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
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Rev Fin 2003; 16:1359-1388
© 2003 the Society for Financial Studies

The Design of Financial Policies in Corporate Spin-offs

Vikas Mehrotra
University of Alberta

Wayne Mikkelson
University of Oregon

Megan Partch
University of Oregon

Address correspondence to Megan Partch, Lundquist College of Business, University of Oregon, Eugene, OR 97403, or e-mail: mpartch{at}lcbmail.uoregon.edu.

Abstract

We examine differences in financial leverage between parent and spun-off firms that emerge from corporate spin-offs. Our tests control for past financing choices and the costs of adjusting capital structure, factors that can obscure cross-sectional patterns among firms' target leverage ratios. We find that firms that emerge from spin-offs with more financial leverage have a higher cash flow return on assets, lower variability of industry operating income, and a greater proportion of fixed assets. The positive relation between profitability and the use of financial leverage, in a setting that is free of pecking order effects, is particularly important because it contrasts with existing evidence. Our results indicate that the ability to cover debt payments and default-related costs are important determinants of the use of financial leverage, as implied by the trade-off theory of capital structure. We find no evidence that managerial incentives or governance characteristics affect the difference in leverage ratios in firms that emerge from spin-offs.


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