The Market Performance of Tracking Stocks

Matthew T. BILLETT and Anand M. VIJH *

Henry B. Tippie College of BusinessUniversity of Iowa, Iowa City, IA 52242-1000

ABSTRACT

Tracking stocks have been a popular form of equity restructuring in recent years. AT&T,Disney, General Motors, Sprint, US West, and many others have issued tracking stocks.While the positive announcement returns of tracking stocks are well documented, anexamination of their post-issue market performance is lacking. This paper examines the post-issue returns and the subsequent restructuring events through December 2000 by using acomprehensive sample of tracking stocks. We document three key results. First, we find thattracking stocks earn significantly negative buy-and-hold excess returns during a three-yearperiod following the issue date. We also find significantly negative returns surrounding theearnings announcements during this period. This evidence contrasts with the post-issuereturns of spinoffs, which are known to be positive, and of carveouts, which are known to beinsignificant. Second, contrary to a common justification given to adopt tracking stocks, wefind that they do not increase the transparency of firm earnings. Third, we find large positiveannouncement-period returns to events resulting in the elimination of tracking stock structure.

JEL Classification: G12; G14; G24; G34.

Keywords: Tracking stocks; Divestitures; Second events; Long-term returns; Event study.

Current version: February 2001

Comments welcome

* E-mail: Matt-Billett@uiowa.edu and Anand-Vijh@uiowa.edu. Phone: (319) 335-2626 and (319) 335-0921. Thepaper has benefited from comments of seminar participants at the Case Western Reserve University, the Universityof Missouri, and the University of Oklahoma. We wish to thank Jon Garfinkel and Ingo Natusch for helpfulsuggestions. We are obliged to Mr. Stan Levine of the Thomson Financial Company for providing the First Callanalyst forecast data.

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The Market Performance of Tracking Stocks

1. Introduction

Tracking stocks are big news. On November 22, 1999, the Wall Street Journal reported that

AT&T was moving closer to issuing a tracking stock for its fast-growing wireless unit. AT&T’s stock

rose by 11.81 percent that day. This was AT&T’s biggest one-day return in a decade, even exceeding the

return following the September 1995 announcement that it would spinoff its NCR computer business.

Tracking stocks were first introduced in 1984 with the creation of GME shares issued by General Motors,

to track the performance of its Electronic Data Systems (EDS) division. General Motors followed with

another tracking stock, GMH, to track the performance of its Hughes Aircraft division, but the next

company to adopt a tracking stock was not until 1991 when USX Corp. separated its oil business from its

steel business. While relatively rare until the mid 1990s, tracking stocks have become an increasingly

popular form of restructuring. Many companies have issued or proposed issuing tracking stocks,

including AT&T, Disney, DLJ, DuPont, General Motors, Microsoft, R.J. Reynolds, Sprint, TCI, USX

Corp., US West, and WorldCom.

What are tracking stocks? These are newly-issued stocks; created by distributing a non-taxable

stock dividend to existing shareholders, by an initial public offering, or as payment for target shares in a

merger. A tracking stock is an equity claim intended to reflect the performance of a certain division of a

multi-division firm. We refer to the old stock as the general division (GD) stock and the new stock as the

tracking (TR) stock. Tracking stocks differ from spinoffs and carveouts that also divide the cash flows of

the old firm. Whereas spinoffs and carveouts divide the old firm into two separate firms with distinct

boundaries, tracking stocks leave it as one combined firm for legal purposes. This distinction is important,

as many benefits of divestitures are believed to result from the complete separation of non-synergistic

businesses. Numerous studies document that increasing firm focus by divestiture is associated with an

increase in firm value, regardless of whether the divestiture is accomplished by an asset sale, a spinoff, or

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a carveout.1 This benefit of divestitures is unachievable with tracking stocks. The complete separation of

businesses also removes potential conflicts arising from the division of cash flows.

Hass (1996), Logue, Seward, and Walsh (1996), Billett and Mauer (2000), D’Souza and Jacob

(2000), Elder and Westra (2000), and Zuta (2000) discuss the pros of tracking stocks. First and foremost,

firms issuing tracking stocks often argue that the analysts and investors cannot understand the value of

disparate businesses and therefore undervalue the combined stock. Creation of quasi pure-play tracking

stocks attracts greater analyst coverage (the transparency effect) and increases attention from investors

interested in different parts of the firm’s business (the clientele effect). Second, tracking stocks help

attract and retain top managerial talent, whose compensation can be linked to the market value of their

divisions. Third, tracking stocks help in accomplishing mergers with target firms whose shareholders are

less willing to exchange their stock for the stock of a large and diversified acquiring firm. Fourth, tracking

stocks preserve the internal capital markets of diversified firms.

Consistent with these arguments, Logue, Seward, and Walsh (1996), Billett and Mauer (2000),

D’Souza and Jacob (2000), and Zuta (2000) document mean announcement returns of around three

percent, which are of the same order as the announcement returns for spinoffs and carveouts.2 Billett and

Mauer (2000) find a positive relation between the announcement returns and the wealth gains or losses

from preserving the internal capital markets of the combined firm. The cons of tracking stocks are

discussed by Hass (1996), who argues that these are fictional stocks that may create potential conflicts of

interest, arising from disproportionate ownership of the GD and TR stocks by directors and managers and

sibling rivalry between shareholders of the two stocks.

This paper examines the long-term market performance of this unique form of restructuring that

separates the stocks without separating the businesses. We analyze 28 TR and 19 GD stocks that were

issued during 1984-1998. Our sample includes every tracking stock issued in the U.S. market during this

1 Lang and Stulz (1994), Berger and Ofek (1995, 1999), and Comment and Jarrell (1995) document that focus andfirm value are positively related and that firm value increases when focus is improved. John and Ofek (1995), Desaiand Jain (1999), and Vijh (1999) find that focus-increasing divestitures are associated with greater wealth gains forsamples of asset sales, spinoffs, and careveouts, respectively.2 See Hite and Owers (1983), Miles and Rosenfeld (1983), and Schipper and Smith (1983) for the announcementreturns of spinoffs, and Schipper and Smith (1986) for the announcement returns of carveouts.

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period. We first measure the buy-and-hold excess returns (BHERs) over a one-year period before the

announcement date, between the announcement and issue date, and over a three-year period after the

issue date. We compute these excess returns by using three different benchmarks: the Center for Research

in Security Prices (CRSP) value-weighted market returns, the Media General Financial Services (MGFS)

industry returns, and the CRSP size decile returns.

We find that GD stocks underperform the market and size decile benchmarks during the pre-

announcement period. On average, the BHERs are significantly negative. This evidence contrasts tracking

stocks with spinoffs and carveouts. Desai and Jain (1999) find that pre-announcement BHERs of spinoffs

are insignificant, and Vijh (1999) finds that pre-announcement BHERs of carveouts are significantly

positive. The evidence supports a frequent conjecture that tracking stocks are issued in response to poor

stock price performance. The industry-adjusted BHERs are insignificant, which suggests that the industry

as a whole may be underperforming.

The pre-issue BHERs, spanning the period from just before the announcement date to the issue

date, are generally insignificant. The post-issue returns are of the greatest interest, as this is when the TR

stocks begin their lives. Over a three-year holding period starting with the issue date and ending no later

than December 2000, the GD stocks earn BHERs that are negative but insignificant. However, the TR

stocks earn BHERs that are negative and statistically significant with respect to all three benchmarks.

Nineteen of the 28 TR stocks underperform all three benchmarks, only five outperform all three, and four

are in-between. To give some feel for the magnitude of underperformance, the TR stocks earn an average

buy-and-hold return of 20.9 percent. Over an average holding period of 2.70 years, this translates into an

annual raw return of 7.3 percent. In comparison, the annual market return equals 19.3 percent, the annual

industry return equals 16.0 percent, and the annual size decile return equals 14.7 percent. The difference

between the annual raw return and the benchmark return ranges between 7.4 and 12.0 percent, which is

economically significant.

We next examine several subsets of data to test the reasons given to explain the issuance decision.

We find that none of the subset BHERs are significantly positive, while many are significantly negative.

First, during the post-issue period, the smaller TR stocks earn significantly negative returns, which are

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also significantly less than the returns earned by the bigger TR stocks. It appears that issuing tracking

stocks linked to small divisions is not in the shareholders’ interest. Second, TR stocks that partition a firm

into growth and value divisions earn insignificant returns while TR stocks that achieve no such purpose

earn significantly negative returns. Third, TR stocks that are issued as part of mergers earn significantly

negative returns. Thus, receiving payment in the form of a TR stock instead of the acquirer’s old stock

does not benefit the target shareholders.

Tests of long-term returns are sometimes criticized because they cannot control for all known

factors in stock returns. In comparison, tests of short-term event-period returns are free of such criticism.

We therefore examine three-day announcement-period returns for all quarterly earnings announcements

of GD and TR stocks during the same three-year holding period. Consistent with the evidence on long-

term returns, the earnings announcement-period returns of GD stocks are insignificant, but the earnings

announcement-period returns of TR stocks are significantly negative. In fact, nearly one-third of the

negative BHERs of TR stocks during the three-year holding period can be explained by the negative

earnings announcement returns.

After examining stock returns, we investigate the common transparency argument given to justify

the creation of tracking stocks. Using the First Call analyst forecast data, we examine the forecast errors

for the combined stock during the four quarters before announcement and the separated stocks during the

four quarters after issue. We find no decrease in the magnitude of forecast errors for GD stocks, but a

significant increase for TR stocks. We next examine the dispersion of multiple analyst forecasts for any

given quarter, and find a small decrease for GD stocks but a large increase for TR stocks. We finally

examine the magnitude of the market reaction to earnings announcements. The market reaction increases

for both GD and TR stocks, but the difference is not statistically significant. Overall, these tests provide

evidence that is inconsistent with the increased transparency argument. There is no improvement in the

transparency of GD stocks from before announcement to after issue, and there may be some deterioration

in the transparency of TR stocks.

The combined evidence on three-year holding-period returns, earnings announcement-period

returns, and the transparency of firm’s earnings suggests that TR stocks are poor performers while the GD

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stocks are average performers. This evidence is inconsistent with market efficiency, although we must

caution that tracking stocks are relatively new and their population is relatively small. The long-term

evidence in our study contrasts with previous studies of tracking stocks that document positive market

reaction on the announcement of tracking stocks. It also contrasts tracking stocks with spinoffs and

carveouts. Cusatis, Miles, and Woolridge (1993) and Desai and Jain (1999) document that the spinoff

subsidiary stocks earn significantly positive long-term excess returns, and Vijh (1999) shows that the

carveout subsidiary stocks earn insignificant excess returns. If the poor long-term returns reflect problems

that were not foreseen, then we would expect many reversals of the tracking stock structure in favor of the

old one-stock structure. We would also expect complete divestitures of tracked businesses by spinoff or

selloff. In addition, we would expect positive market reaction following the announcement of such

reversals and divestitures.

To test these predictions, we investigate subsequent restructuring events of TR stocks through

December 2000. Eight TR stocks have been retired (or proposed to be retired) in favor of the old one-

stock structure, two have been sold, and two have been spun off. In addition, two TR stocks have been

acquired (or proposed to be acquired) along with their GD stock, one has been partially divested by the

GD management, and one has been restructured after acquiring another firm. In most cases, the

announcement of restructuring events that lead to the elimination of the tracking stock structure is

accompanied by strong positive returns to both the TR and GD shareholders. For example, the eight TR

stocks that were exchanged for the GD stock realize an average market-adjusted excess return of 19.0

percent, while the corresponding GD stocks realize 7.4 percent. However, the two stocks often react

differently, and in a manner consistent with conflicts of interest between their shareholders as highlighted

by the media reports. A study of such media reports on the announcement of restructuring events and

surrounding events that lead to the elimination of tracking stock structure suggest that TR stocks often

create more problems than they solve. We cite evidence of confusion among the analysts and the

shareholders as to what they really own, TR shareholders complaining of unfair treatment in dividing the

proceeds of restructuring, cross-liability resulting from maintaining the firm as one legal entity, and so on.

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Hass (1996) and many articles in the press have pointed out these problems.3 Why the proponents of

tracking stocks did not foresee these problems at the time of issuing TR stocks is not clear.

Where does that leave us? We are unable to explain the market’s preference for tracking stocks as

shown by the positive announcement returns. It is possible that tracking stocks are advisable in some

cases and not advisable in other cases. However, we are unable to find circumstances under which

tracking stocks are advisable and leave this topic to future research. The remaining paper proceeds as

follows. Section 2 discusses data and methods. Section 3 examines the market performance with long-

term returns and earnings announcement returns. Section 4 examines the transparency argument, and

Section 5 examines the subsequent restructuring events. Section 6 concludes.

2. Data and methods

2.1. Sample (universe) of tracking stocks during 1984-1998

Our sample of tracking stocks is obtained from Billett and Mauer (2000) and D’Souza and Jacob

(2000) and includes every tracking stock issued in the U.S. market during 1984-1998. It includes 20

issues by 14 firms. However, our sample is smaller than the cumulative sample of the above two papers as

we exclude cases where tracking stocks were announced but not issued before December 1998.4 Eight

firms issued tracking stocks once during the sample period (Ralston Purina Group, CMS Energy Corp.,

US West Inc., Inco Ltd., Conectiv Inc., Georgia Pacific Corp., Circuit Stores Inc., and Sprint Corp.). Six

firms issued tracking stocks twice (General Motors Corp., USX Marathon Group, Pittston Company,

Fletcher Challenge Group, Genzyme Corp., and Tele Communications Inc.). Following 19 of the 20

issues, we can unambiguously identify one GD stock and one or more TR stocks. But, in the singular case

of Fletcher Challenge Group, there are four comparable-size stocks after the second issue date of March

25, 1996, which are all classified as TR stocks. The overall sample includes 14 different GD stocks and

22 different TR stocks. However, since each issue date is treated as an independent event, there are 19

GD and 28 TR stock observations in the return measurement experiments. In five cases there is some

3 See Burton (1998), McGough (1999 and 2000), Rowland (1999)), Sloan (1999), Vickers (1999), Adamson (2000),Henry (2000), Lashinsky (2000), Malkiel (2000), Scherreik (2000), and Stires (2000).4 We also exclude one issue by American Health Properties, because it was a real estate investment trust, a preferredstock, and unavailable on the CRSP database.

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overlap between observations as the second issue occurs less than three years after the first issue. This

violates the assumed independence of the second event. However, the overlap averages only 1.12 years.

Our sample is small, especially for the long-term returns part of our investigation. But it includes

the entire population of tracking stocks. Moreover, our results are both economically and statistically

significant. Later, we separately analyze a sample of six GD and eight TR stocks that were issued

between January 1999 and April 2000. The available data cover a much shorter period for these stocks, so

we prefer to analyze them separately.

We obtain the announcement dates of tracking stock issues from Billett and Mauer (2000) and the

Wall Street Journal and the issue dates by tracing the first trading date of TR stocks on the CRSP files.

The actual issue date is likely to be on the previous day, but for convenience of exposition we term the

first trading date as the issue date. We obtain the earnings announcement dates from the Compustat

quarterly file and Lexis/Nexis, and the announcement dates and details of subsequent restructuring events

from the Wall Street Journal and Lexis/Nexis.

2.2. Sample distribution over time and the summary statistics

Panel A of Table 1 reports the timing and frequency of firms issuing tracking stocks and the

number of tracking stocks issued. While GM first introduced tracking stocks in 1984 and 1985, the next

company to adopt a tracking stock structure was USX Corp. in 1991. The gap between 1985 and 1991

was primarily due to uncertainty regarding the tax treatment of future tracking stocks. In 1991 USX

solved this problem and structured their tracking stock in such a way that it was ruled a tax-free event.

USX’s example led to the wave of tracking stocks that followed.5 Table 1 shows that one company issued

tracking stocks during 1992 and 1994 and three companies issued tracking stocks during 1993 and each

year from 1995 to 1998.

Panel B of Table 1 reports the sample characteristics. The average tracking stock has a market

value of $1.6 billion and ranges from $16 million to $9 billion. The ratio of TR to GD market value

averages 0.237. Krishnaswami and Subramaniam (1999) report that the ratio of subsidiary to parent

5 While the IRS has decided not to issue rulings on tracking stocks, the consensus is that for the time being they willbe treated as a tax-free form of restructuring (Natusch (2000)).

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market value averages 0.27 for spinoffs, and Vijh (1999) reports that the ratio of offering value to the

parent market value averages 0.159 for carveouts.6 Thus, in terms of relative size, tracking stocks are

comparable to other forms of equity restructuring.

Issuers cite a variety of reasons for creating tracking stocks. We find that 29 percent of tracking

stocks are the result of a merger where the TR stock gives target shareholders an issue closely aligned to

the performance of their old business. Transparency issues and clientele effects are almost always given

to justify the issuance of tracking stock. However, we find that 29 percent of our sample of TR stocks are

in the same industry as their GD stocks. Transparency and clientele effects are less likely to be the main

motivation in these transactions. Finally, 39 percent of the TR stocks divide the combined stock into a

growth stock and a value stock. In these cases the separated stocks may be designed to better serve the

perceived investor clienteles.

Insider holdings align the interests of the managers and other insiders with the interests of the

shareholders. One may argue that proportionate holdings of TR and GD stocks would motivate managers

to maximize the market value of the combined firm, and disproportionate holdings would motivate them

to increase one stock price at the expense of the other. Table 1 reports insider holdings collected from the

first proxy statement available after the issuance of tracking stocks. On average, insiders own 3.1 percent

of the TR stocks and 2.8 percent of the GD stocks. The average ratio of TR to GD holdings equals 5.36.

The median is a better indicator, and it equals 1.01. There is considerable cross-sectional variation, and

most firms have insider holdings of GD stock substantially different from insider holdings of TR stock.

Although not reported, we found that the ratio of CEO holdings of TR to GD stocks is comparable to the

ratio of insider holdings, but less skewed, with an average value of 0.79 and a median value of 0.87.

2.3. The returns data and the computation of excess returns

We compute excess returns by using three different benchmarks to control for the market,

industry, and size effects. The computation requires the stock returns, market returns, industry returns,

and size decile returns. We obtain all of these returns except industry returns from the CRSP daily return

6 Strictly speaking, Krishnaswami and Subramaniam (1999) report the average ratio of the spinoff to the sum ofspinoff and parent value. However, from this we calculate the ratio of spinoff to parent value.

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files ending in December 2000.7 We proxy market returns by returns on the CRSP value-weighted

portfolio of NYSE, AMEX, and NASDAQ stocks (symbol VWRETD).

Most studies of long-term returns adjust for industry effects by matching sample stocks with other

stocks having the same standard industrial classification (SIC) code on CRSP or Compustat files. A

recent paper by Kahle and Walkling (1996) documents that 36 percent of the Compustat and CRSP

primary SIC codes disagree at the 2-digit level, 50 percent disagree at the 3-digit level, and 79 percent

disagree at the 4-digit level, which questions the effectiveness of this procedure. The potential

misclassification problem is more acute for tracking stocks. For example, CRSP assigns the same SIC

code of 3711 to GM, GME, and GMH stocks. This code stands for “Motor Vehicles and Car Bodies”,

which is descriptive of GM, but not GME or GMH. We searched for alternate sources of industry

classification and found a superior source in MGFS. This is a financial services concern that maintains

215 industry indexes. Their classification agrees with hard copy sources that describe the business lines of

TR and GD stocks. In the preceding example, MGFS assigns industry groups of “Auto Manufacturers –

Major” to GM, “Information Technology Services” to GME (now EDS), and “Communication

Equipment” to GMH. The MGFS industry classification and returns data have become an industry

standard and are used by numerous financial service and information providers. We use the MGFS

industry returns data in our analysis, retrieved from the web-site moneycentral.msn.com (owned by the

Microsoft Corporation). The data are available for the entire period of our study. However, there is one

limitation, that cash dividends are excluded in computing the index returns. As a result, the true industry-

adjusted excess returns are likely to be more negative than our reported industry-adjusted excess returns.

We calculate that the GD and TR stocks included in our study have average annualized dividend yields of

2.82 and 1.95 percent during the sample period.

We compute long-term excess returns by subtracting the buy-and-hold market returns, industry

returns, or size-decile returns from the buy-and-hold stock returns over an appropriate holding period. The

resulting buy-and-hold excess returns, or BHERs, are an accurate measure of excess returns realized by

7 To be more precise, we use the size decile returns for the relevant exchange (NYSE or NASDAQ) that are includedin the CRSP index files. However, for brevity of exposition, we refer to these as the size decile returns.

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the long-term shareholders of TR and GD stocks. The underlying buy-and-hold portfolio strategy is easy

to implement and requires no subsequent rebalancing. We compute short-term announcement-period

excess returns by subtracting the three-day cumulative market returns from stock returns. The three-day

measurement period is centered on the event date, which is either the Compustat announcement date or

the Wall Street Journal or Lexis/Nexis publication date. For both long-term and short-term experiments,

we compute t-statistics by using the cross-sectional distribution of excess returns.

In addition to the returns data, this paper analyzes the First Call analyst forecast data obtained

from the Thomson Corporation. We describe this later when we report empirical tests based on these data.

3. Long-term returns and earnings announcement-period returns

3.1. BHERs of the aggregate sample of GD and TR stocks

Table 2 presents the BHERs of the GD and TR stocks. We examine the stock price performance

over the year prior to announcing the tracking stock, the period between announcement and issue, and the

three years following the issue. Over the year prior to announcement, the GD stocks earn an average 0.67

percent raw return, -16.14 percent market-adjusted return (significant at the one-percent level), -4.35

percent industry-adjusted return (insignificant), and -16.57 percent size-adjusted return (significant at the

one-percent level). The medians present an almost identical picture. Ten of the 18 raw returns are

negative. Thus, one plausible motivation for issuing tracking stocks may be to bolster poor stock price

performance.

This evidence of negative pre-announcement performance is in stark contrast to other forms of

equity restructuring. Desai and Jain (1999) find insignificant BHERs prior to spinoffs. Vijh (1999) finds

that the pre-announcement BHERs of carveouts are significantly positive. If firms issue tracking stocks in

an attempt to improve stock market performance, then it would be interesting to ask whether this new

form of equity restructuring succeeds in improving the GD stock price performance. Table 2 shows that

the BHERs of GD stocks over a three-year period starting with the issue date average -4.15, -4.86, and

-0.96 percent with reference to the market, industry, and size-decile benchmarks. All figures are

statistically insignificant, and arguably economically insignificant. The BHERs during the period between

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the announcement and issue date are also insignificant, except with reference to the industry benchmark.

Both the pre-issue and post-issue BHERs show that the GD stocks no longer underperform after the

announcement of tracking stocks. On average, they earn returns that are statistically indistinguishable

from their benchmarks.

The long-term returns of TR stocks may shed more light on whether these restructurings improve

firm performance. Similar to spinoffs, carveouts, and equity issues, it also makes more sense to examine

the performance of these newly created stocks. The evidence in Table 2 suggests that TR stocks do not

outperform their benchmarks over a three-year period. In fact, they considerably underperform. The mean

three-year market-adjusted, industry-adjusted, and size-adjusted BHERs equal -40.05, -28.41, and -23.76

percent. The associated t-statistics are -2.17, -2.31, and -1.85, significant at the five-percent level in the

first two cases, and ten-percent level in the third case. Following Lyon, Barber, and Tsai (1999), we also

calculate skewness-adjusted t-statistics as

tsa = n0.5 [ S + γ S2/3 + γ/(6n) ] ,

where n is the sample size, S is the ratio of sample average to standard deviation, and γ is the sample

skewness. The skewness-adjusted t-statistics for the market-adjusted, industry-adjusted, and size-adjusted

BHERs equal -2.00, -2.35, and -1.63, which compare favorably with the unadjusted t-statistics. This

shows that skewness is not a major problem in our sample. To further illustrate the statistical significance,

Table 2 shows that the three median BHERs equal -52.81, -28.32, and -29.16 percent, significant at the

five-percent level in each case (not shown in table). Nineteen of the 28 TR stocks earn negative market-

adjusted returns, 21 earn negative industry-adjusted returns, and 21 earn negative size-adjusted returns

(significant in each case at the five-percent level or better).

In addition to the statistical significance, the economic significance of return differences is quite

large. Over the average holding period of 2.70 years, the TR stocks earn an average 20.93 percent return,

which is 40.05 percent less than the market return. This translates into an average annual return of

100×(1.20931/2.70-1) = 7.29 percent for TR stocks and 19.28 percent for the market. A similar calculation

shows an average annual return of 16.01 percent for the industry stocks and 14.66 percent for the size

decile stocks. Recall that the industry return may be understated by about the same order as the 1.95

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percent average annual dividend yield of TR stocks in our sample. The TR stocks thus underperform the

benchmarks by an average of 7.29-(19.28+(16.01+1.95)+14.66)/3 = 10.01 percent a year over a three-year

period after the issue.8

The evidence on long-term returns shows that the TR stocks are poor performers. This evidence is

particularly interesting when contrasted with the announcement-period returns. Previous studies by

Logue, Seward, and Walsh (1996), Billett and Mauer (2000), D'Souza and Jacob (2000), Elder and

Westra (2000), and Zuta (2000) have documented that the announcement of tracking stocks is associated

with an average positive abnormal return of around three percent. These studies interpret the positive

announcement-period returns as evidence that tracking stocks benefit shareholders. Our study suggests

that, at a minimum, they do not benefit the long-term shareholders of TR stocks.

3.2. Cross-sectional differences in BHERs

Table 3 reports the three-year BHERs and the industry classification for each of the GD and TR

stocks in our sample. It is interesting to note that in many cases the industry classification for TR stocks is

the same as that for GD stocks. Also noteworthy is the cross-sectional variation in returns. To get a better

idea of the cross-sectional patterns, Table 4 examines the BHERs of TR stocks by various groups. The

last panel of Table 4 lists which TR stocks are included in these groups.

Panels A and B of Table 4 examine the relation between size and BHERs. Panel A divides the

sample into TR stocks with a market value above the median vs. TR stocks with a market value below the

median. The market value for this purpose is calculated in December 2000 dollars by using the market

returns between the issue date and December 2000. Similarly, Panel B splits the sample above and below

the median ratio of TR to GD market values. Both panels make the same point. The larger TR stocks have

8 We also examine the long-term returns by using the Fama and French three-factor model. For every GD and TRstock, we calculate monthly returns over a period that begins with the first month after the issue month and endsthirty six months later. We calculate the monthly portfolio return by averaging across all GD or TR stock returnsduring a calendar month. The model regresses the difference between the monthly portfolio return and the riskfreereturn on the following three factors: the difference between the market return and riskfree return, the differencebetween returns on portfolios of small and big stocks, and the difference between returns on portfolios of high andlow book-to-market stocks. The intercept in this model serves as a measure of abnormal returns. In unreportedresults, we find that the intercept for both the GD and TR regressions is insignificant. This is perhaps not surprisingin view of our small sample size. For example, the TR calendar-time portfolio consists of a single stock during one-fifth of the sample period, and has no more than 14 stocks during any one-month period. Given the sample andtiming characteristics of tracking stocks, we are uncomfortable making any inferences based on these tests.

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insignificant mean and median BHERs while the smaller TR stocks have significantly negative mean and

median BHERs. The smaller TR stocks also have BHERs that are statistically different from the larger

TR stocks.

An interesting question concerns the relationship between the pre-announcement performance of

the old firm and the post-issue performance of the track. Panel C examines the BHERs classified by

whether the GD stock was a poor performer during the year prior to tracking stock announcement. We

find that there is practically no significant relationship between the pre-announcement performance of GD

stocks and the post-issue performance of TR stocks.

Firms issuing tracking stocks often argue that they appeal to a broader investor clientele or that

they enhance the firm transparency. Panel D partitions the sample into tracking stocks that divide the firm

into a growth stock and a value stock vs. those that have the TR and the GD both classified as a value

stock or both classified as a growth stock. We find that TR stocks that separate the firm into a growth and

a value stock do not earn BHERs that are significantly different from zero. However, TR stocks that fail

to create such distinctive stocks earn significantly negative BHERs. The difference between these two

groups is also significant. While there is no evidence to suggest that TR stocks that distinguish growth

and value divisions increase stockholder wealth, there is some evidence to suggest that TR stocks that do

not provide such distinction destroy shareholder wealth.

Panel E reports the results when the sample is stratified according to whether the TR and GD

stocks belong to the same industry or different industries. We find no statistical difference between the

two groups, although the returns are significantly negative when the TR and GD stocks belong to

different industries. Panel F breaks the sample into TR stocks that were merger related vs. the others.

Again, the BHERs of the two sub-samples are statistically indistinguishable, although the industry-

adjusted and size-adjusted BHERs are significantly negative for the merger-related sub-sample.

Panels G uses the insider holdings of the GD and TR to determine whether the TR stock returns

are correlated with the incentives created by differential stock holdings. It shows that BHERs of cases

where the insiders own a smaller percentage of GD stock than TR stock are statistically indistinguishable

from cases where the insiders own a larger percentage of GD stock than TR stock. Panel H divides the

14

sample into subsets with insider holdings of TR stock above and below the median. The BHERs of TR

stocks with above median insider holdings are insignificantly different from zero, while the BHERs of TR

stocks with below median insider holdings are significantly negative. However, the difference between

the two subset BHERs is not significant. Finally, although not reported in Table 4, we split the sample by

using the CEO holdings in place of the insider holdings. The results are very similar.

The combined cross-sectional evidence shows that smaller TR stocks perform worse than larger

TR stocks, TR stocks that do not separate the growth and value components of the old stock perform

worse than those that do, but that there is no difference in performance based on pre-announcement

returns, differential insider holdings, industry affiliations of the GD stock vs. the TR stock, and whether

the issue is merger related. It is also remarkable that not one of the 96 subset BHERs in Table 4 is both

positive and significantly different from zero.

3.3. Additional evidence on BHERs with recent issues

Appendix 1 and Table A.1 present additional evidence on the post-issue performance by using a

more recent sample of tracking stocks issued between January 1999 and April 2000. The short history of

these more recent TR stocks prevents us from merging this sample with our primary sample. However,

the short history does not hide their poor performance. The average market-adjusted, industry-adjusted,

and size-adjusted BHERs of eight TR stocks issued during this period equal -19.70, -36.19, and -31.63

percent, negative but statistically insignificant, perhaps due to the small sample size.

3.4. Long-term earnings announcement-period returns

Long-term returns should be driven by long-term earnings performance. If investors are over-

optimistic about the prospects of TR stocks at the time of issue, then the earnings announcements should

come as unpleasant surprises. Jegadeesh and Titman (1993) use the earnings announcement-period excess

returns over a three-year period to support their evidence on long-term excess returns of recent winners,

and Jegadeesh (2000) uses a five-year period to support his evidence on long-term excess returns of

seasoned equity offerings. This methodology has the added attraction that short-period excess returns are

robust to the choice of benchmark returns.

15

Table 5 reports an event study of earnings announcement dates for GD stocks during a period of

one year before announcement and three years after issue, and for TR stocks during a period of three

years after issue. The announcement dates are obtained from Compustat, First Call, or Lexis/Nexis (in

that order), and are sometimes unavailable. Earnings announced within the first 63 trading days of

tracking stock issue are classified as quarter +1, within 64 to 126 trading days as quarter +2, etc. The

excess returns are computed by subtracting the cumulative market returns from the stock returns over a

three-day period centered on the earnings announcement date.

Panel A of Table 5 shows that GD stocks earn a mean excess return of 0.57 percent (t-statistic

1.20) during the pre-announcement period. This insignificant excess return suggests that, on average, the

earnings announcements of GD stocks during this period are not significantly different from expectations.

We recall from Table 2 that the industry-adjusted BHERs during this period are also insignificant, but the

market-adjusted and size-adjusted BHERs are significantly negative. Once again, it appears that the poor

performance based on the latter benchmarks may be common to other stocks in the GD industry, and it

may not reflect poor earnings performance of the GD stocks before the announcement of tracking stocks.

The excess returns during the post-issue period average an insignificant -0.08 percent (t-statistic -0.26) for

GD stocks, but a significantly negative -0.94 percent (t-statistic -2.46) for TR stocks. The medians and the

fraction of positive returns confirm the significance of mean returns. Panel B of Table 5 shows that,

averaged across all earnings announcements in an event quarter, the mean excess return is negative in 8

out of 12 cases. For both GD and TR stocks, the post-issue earnings announcement-period excess returns

are consistent with their long-term excess returns.

To explain the economic significance of TR stock announcement-period returns, it is important to

discuss the choice of benchmark excess returns. The above analysis of Table 5 assumes that ex-ante the

mean earnings announcement-period excess return should equal zero. This assumption is questioned by

the classic Robicheck and Myers (1966) ship set-sail story.9 Based on this theory, and using all earnings

9 The Robicheck and Myers (1966) story can be explained as follows. Suppose a ship sets out on a long voyage insearch of a fortune. No information reaches the market during the time the ship is in transit, so the expected returnon equity claims linked to the payoff from the voyage should be the same as risk-free return. The uncertainty isresolved on the day the ship reaches the port. Assuming that the payoff risk cannot be diversified, the expectedreturn on arrival date should be very high.

16

announcements during 1976-1984, Chari, Jagannathan, and Ofer (1988) show that the mean earnings

announcement-period excess return is positive. Casual empiricism suggests that the 1990s were a period

of stronger price increases, and that some of the price increases for individual stocks occurred around the

strong earnings news. We therefore measure the excess returns around all earnings announcements

reported on the Compustat database during 1990-1999. Excluding only stocks with a market value of less

than $10 million or a stock price of less than $3 produces a mean excess return of 0.20 percent.10 Using

this benchmark for earnings surprise leads to an excess return of -(0.20+0.94) = -1.14 percent for TR

stocks, with a t-statistic of -2.46×1.14/0.94 = -2.98.11 It also changes the pre-announcement and post-issue

mean excess returns for GD stocks to 0.37 and -0.28 percent, with t-statistics of 0.78 and -0.91.

An earnings announcement-period excess return of -0.94 percent per quarter explains a

cumulative underperformance of around 100×(1-(1-0.0094)11) = 9.87 percent over 11 announcements for

TR stocks during the average holding period of 2.70 years. An excess return of -1.14 percent explains

11.85 percent. This is roughly one-third of the total long-term underperformance. The combined evidence

suggests that the TR stocks are poor performers during a three-year period after the issue.

4. Earnings transparency of pre-announcement GD stock vs. post-issue GD and TR stocks

One commonly cited reason for issuing tracking stocks is to increase the firm transparency. This

reason would imply that the earnings forecasts of the sample firms should be more accurate following the

track. In other instances, Krishnaswami and Subramaniam (1999) find an increase in the accuracy of

earnings forecasts for a sample of spinoffs, while Gilson, Healy, Noe, and Palepu (1998) find a similar

increase for a combined sample of spinoffs, carveouts, and tracking stocks. Unfortunately, Gilson, Healy,

Noe, and Palepu do not separate their results by the type of restructuring. Below we measure the impact

of tracking stocks on firm transparency by collecting information on the four earnings announcements

before the announcement of a track and the four announcements following the issuance.

10 This excess return is not driven by any one year. Over each year from 1990 to 1999, the mean excess return equals-0.03, 0.40, 0.32, 0.10, 0.05, 0.06, 0.28, 0.07, 0.18, and 0.48 percent. Changing the market value and stock pricefilters to $1 million and $1 increases the ten-year mean excess return to 0.27 percent, and changing filters to $1billion and $10 increases it to 0.33 percent.11 This calculation ignores the small standard error of the benchmark excess return of 0.20 percent.

17

We examine three measures of firm transparency: the magnitude of earnings forecast errors, the

dispersion of earnings forecasts across analysts, and the magnitude of market reaction to actual earnings

announcements. We calculate forecast errors for each quarter, defined as the actual earnings minus the

average forecast all scaled by the stock price, and examine the standard deviation of forecast errors before

announcement and after issue. Table 6 shows that there is no significant difference for GD stocks.

However, the evidence for TR stocks is unanimous. In all eight cases where we have adequate data, the

standard deviation of forecast errors is larger for TR stocks than for the pre-announcement GD stocks.

We next analyze the dispersion of forecasts across analysts. The standard deviation of forecasts

should be lower if the track increases the firm transparency. For GD stocks, we find that the average

standard deviation of forecasts declines slightly after the track. The difference is small and statistically

insignificant, although the number of decreases, 11, is more than the number of increases, 3, at the ten-

percent level. For TR stocks the evidence is the opposite. The standard deviation of forecasts for TR

stocks is three times as large as that for the pre-announcement GD stocks, and the difference is significant

at the five-percent level. The non-parametric evidence is stronger. In all nine cases with adequate data, the

TR stock had a larger standard deviation of forecasts than the pre-announcement GD stock.

As a final measure of transparency, we examine the market reaction to earnings announcements.

The standard deviation of the four market-adjusted earnings announcement returns to the GD stocks is

slightly larger after the issue, but the difference is statistically insignificant. The corresponding increase

for the TR stocks is bigger, but remains statistically insignificant.

The combined evidence of Table 6 suggests that there is no improvement in the firm transparency

after the issuance of tracking stocks. There is no systematic decrease in earnings forecast errors, the

dispersion of earnings forecasts across analysts, or the earnings surprise as measured by the market

reaction to actual earnings announcements. There may even be some deterioration in transparency,

especially for the TR stocks. This evidence contrasts tracking stocks with spinoffs that lead to improved

transparency of the parent stocks as documented by Krishnaswami and Subramaniam (1999). It appears

unlikely that the separation of stocks without the separation of underlying businesses makes the valuation

of new GD and TR stocks easier than the valuation of old GD stock.

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5. Subsequent events resulting in the elimination of tracking stocks

A number of firms adopting tracking stocks subsequently eliminate them. We examine the

motivation and wealth effects of all events that result in the partial or complete elimination of tracking

stocks. To identify these events, we search the Wall Street Journal and Lexis/Nexis from the date of TR

issuance through December 2000. The events fall into one of four categories: formal retirement of the

entire tracking stock structure, sale of assets associated with a TR stock resulting in its elimination,

spinoff of a TR stock, and other miscellaneous events related to the tracking stock structure. Table 7

shows the market-adjusted excess returns earned by the TR and GD stocks following the announcement

of such events.

We have two main results. First, on average, the elimination of TR stocks results in positive

wealth effects for both the TR and GD stocks. Twelve out of 14 TR stocks realize positive excess returns,

and five out of seven GD stocks also realize positive excess returns. Second, for a given firm, there can be

substantial differences in the reaction of the TR and GD stocks. Differential price reaction suggests that

the tracking stock structure successfully separates a firm into distinct economic entities. However, the

differential price reaction also indicates that a tracking stock structure leads to conflicts of interest

between the TR and GD shareholders. For example, a common method used to retire TR stock involves

exchanging TR shares for GD shares at a pre-specified premium, resulting in a wealth transfer between

the two classes of shareholders. We examine these events in detail below. Appendix 2 contains a

description of the transactions used to eliminate the tracking stock structure.12

Panel A of Table 7 shows four companies that announce their intention to retire the TR stock by

exchanging it for the GD stock. This group includes CMS Energy, Pittston, Fletcher Challenge, and Inco

Ltd., involving eight TR stocks and three GD stocks. The average announcement-period excess return

equals 19.03 percent for the eight TR stocks, significant at the one-percent level.13 The three GD stocks

12 The TR stock prospectus usually states the methods and conditions under which the firm can retire the TR stock.These methods include: 1. Exchanging GD shares for TR shares, typically at a 15 to 20 percent premium, 2. Sellingor liquidating the assets associated with the TR division and paying the net proceeds to TR shareholders, and 3.Spinning off the TR division. Of course, following a common practice in stock transactions, at any time after issuethe GD firm can make a tender offer to retire the TR shares.13 Because the eight TR stocks belong to four firms, one may argue that the events are not independent and thereforethe significance level is overstated. To address this problem, we average across all TR stocks for a given firm. The

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earn an excess return of 7.40 percent. These excess returns are quite large, especially compared to the

1.58 percent mean excess return associated with the announcement of adopting a tracking stock structure

in Billett and Mauer (2000).14

We gather information on the motives for eliminating the TR structure. The managers of CMS

Energy argued the TR stock had served its purpose and was no longer necessary:

“While Class G stock helped CMS Energy gain market recognition for our gas utilitybusiness when it was first issued in 1995, our gas business has since grown … to thepoint where having a separate tracking stock for our gas utility is no longer useful,” saidWilliam T. McCormick, Jr., CMS Energy’s chairman and chief executive officer.(Source: PR Newswire, September 9, 1999.)

Pursuant to this goal, the CPG (TR) shares were exchanged for CMS (GD) shares at a 15 percent

premium to the pre-announcement market value. Presumably, this premium came at the expense of GD

shareholders. The announcement returns are consistent with this notion. CPG stock price went up by

14.17 percent after adjusting for the market returns while CMS stock price went down by 1.27 percent.

While the reasons given by CMS Energy suggest that the tracking stock structure may have

served some useful purpose at some time, the reasons given by the managers of Pittston, Fletcher

Challenge, and Inco Ltd. for retiring TR stocks suggest that the tracking stock structure simply caused

more problems than it solved. In resolving to dismantle the tracking stock structure, Mr. Kerry Hoggard,

the chairman of the board of directors of Fletcher Challenge, stated:

It is clear that the Group’s capital structure is seen as complex by investors, is perceivedto raise governance issues, and has resulted in a significant structural discount beingapplied to all our stocks. We cannot allow this to continue, and will move as quickly aspossible to a full dismantling of the targeted share structure. (Source: Fletcher Challengepress release, December 16, 1999.)

This statement is particularly interesting in view of the fact that firms adopting tracking stock structures

often cite increased transparency and elimination of a conglomerate value discount as primary motives.

combined excess returns equal 14.17 percent for CMS (unchanged), 29.61 percent for Pittston, 12.72 percent forFletcher, and 27.98 percent for Inco Ltd. (unchanged). The average of these four composite returns equals 21.12percent (t-statistics 4.74), which is significant at the five-percent level, despite only four observations.14 The mean announcement returns to the creation of only these four dismantled TR stocks average 0.67 percent (ineach individual case, 0.81 percent for CMS Energy, 4.55 and 5.46 percent for the first and second announcements byPittston, 1.60 percent for the second announcement by Fletcher (first is unavailable), and -9.08 percent for Inco).

20

Michael Dan, chairman and CEO of Pittston, gave similar reasons for dismantling the tracking stock

structure of Pittston:

“The value of the businesses are not being reflected under the structure of trackingstocks,” Michael T. Dan, Pittston’s chairman and chief executive, said. A major reasonfor that, Mr. Dan said, is that the coal business and its liabilities have “cast a shadow” onthe other two businesses. (Source: Wall Street Journal, December 6, 1999.)

Finally, Inco Ltd. provides a compelling example of the conflicts of interest that can arise

between TR and GD shareholders. Such conflicts caused internal strife among Inco’s board members and

hindered their corporate decision making. To eliminate the problem, Inco’s board made a tender offer for

the TR shares. However, some of the largest TR shareholders felt they were being coerced to take less

than the fair value of their shares and resisted the offer. After a number of tender offers failed to gain the

needed 90 percent approval, Inco called a special shareholder meeting where a 66 percent majority would

force all TR shareholders to accept the offer. The resolution passed and the meeting was described as

follows:

Inco Ltd. hopes it will find corporate harmony on its board after buying out a group ofshareholders whose only interest – represented by two directors – was in the nickelproducer’s stalled Voisey’s Bay development. Despite a handful of disgruntled investorswho attended a special meeting Tuesday, 84.6 per cent of the Voisey’s Bay Nickelshareholders voted to approve the $195-million cash buyout which forced all othershareholders to tender their VBN shares. Inco says the move will prevent “conflict” froma group of shareholders who had a specific interest in one project of the company and twovoices representing their interests on Inco’s board of directors. “The whole notion ofhaving this special class of shares has created conflict,” said Alan Stubbs, Inco’s vicepresident of public affairs. “It complicates the decision process,” he said, adding that thetwo board members have since tendered their resignations. (Source: Canadian PressNewswire, November 28, 2000.)

Following the meeting a number of TR shareholders threatened to sue Inco over the “unfair” value they

were being forced to accept. In the same story, an analyst with Morgan Stanley states: “It was probably

pretty smart to buy (back the shares) now,” adding that the value will go up as the project comes closer to

development.

Panel B of Table 7 contains the two tracking stocks in our sample that were eliminated through an

asset sale. Ralston sold the assets of its Continental Baking Group, representing by the TR stock CBG.

Interestingly, the market-adjusted returns at announcement are -9.66 percent for the TR stock and 0.85

21

percent for the GD stock. On the announcement date, it was unclear how Ralston would handle the

transaction, although the net proceeds were roughly in line with the pre-announcement market-value of

CBG. At a later date, Ralston chose to exchange the TR shares for GD shares at a 15 percent premium

instead of paying the net proceeds directly to CBG shareholders.15

USX had a different experience when it sold the assets related to its Delhi Group. Unlike Ralston,

USX clearly stated its intention to pay the net proceeds directly to the DGP (TR) shareholders. The DGP

stock gained by 19.80 percent. In addition, the event resulted in X (a sibling TR) and MRO (GD) stocks

appreciating by 3.78 and 3.69 percent after adjusting for the market returns. These figures compare

favorably with the average excess return of 1.5 percent following the announcement of asset sales in

general reported by John and Ofek (1995).

Panel C of Table 7 reports that two firms in our sample spun off TR stocks. GM spun off the

GME stock (now EDS), resulting in an excess returns of 7.33 percent for the GME shareholders and -1.53

percent for the GM shareholders. US West also spun off its Media One Group. The resulting excess

returns were 3.99 percent for the TR shareholders, and 4.14 percent for the GD shareholders. These

figures compare favorably with spinoffs in general. Cusatis, Miles, and Woolridge (1993) document 2.1

percent market-adjusted excess returns for their sample of spinoffs.

The terms of the spinoff of GME included a one-time payment from GME to GM. Shareholders

of both GM and GME agreed that a payment was in order. However, the magnitude of the payment was a

source of contention. Arguments put the payment in the range of $200 million to $1 billion:

Some large GM common shareholders and analysts believe the talks ultimately willcenter on a one-time payout, or dividend. “The freedom to be on your own should beworth something,” said one major GM shareholder who wants GM to extract a heftydividend from EDS for its independence. (Source: Wall Street Journal, October 9, 1995.)

Making matters more complex, GM’s pension plan was one of the largest shareholders of GME stock.

The final payment was $500 million, which was 2.6 percent of GME’s market value two days prior to the

announcement or 8.4 percent of GM’s 31 percent stake in GME.

15 Typically the firm can choose between paying the net proceeds, defined as the sale proceeds minus allocated debt,taxes, and other expenses, and exchanging TR shares for GD shares. In the case of Ralston it is unclear whether thechoice of method was in the interests of TR shareholder, GD shareholders, or both.

22

Panel D of Table 7 contains all other events related to the removal of a TR stock. Following the

spinoff of GME, many speculate that GMH, the remaining TR stock, is also likely to be spun off.

Numerous analysts continue to argue that both GM and GMH shareholders would be better off if the units

were legally separated:

J.P. Morgan aerospace analyst Roger Threlfall says that Hughes shares could be valued at$70 to $75 each in a spinoff/breakup scenario. On Friday, GM Class H shares closed at56 1/2, up 1 1/8. GM Class H shares represent a dividend claim on Hughes earnings, butnot an ownership interest. Splitting Hughes off could also boost the valuation of GMcommon shares, some analysts say. GM shares have been trading at about 3.3 times thecompany’s auto-related earnings, Donaldson Lufkin Jenrette analyst Wendy Needhamsays, compared to 6.3 times for Ford and 5.6 for Chrysler. One reason: Both Ford andChrysler have shed nonauto operations. “GM is way undervalued as a company,” shesays. GM common closed Friday at 49 1/4, up 1. J.P. Morgan auto analyst David Bradleysays that shedding Hughes could add $16 each to the value of GM shares. “GM suffersfrom a conglomerate discount,” Mr. Bradley says. (Source: The Wall Street Journal,September 16, 1996.)

On June 2, 1998, John F. Smith, Jr., GM’s chairman, formally announced that GM had no intention to

spin off Hughes. Consistent with the positive returns when spinoffs are announced, GMH earned a -7.47

percent return following the announcement. Interestingly, GM shares went up by 5.38 percent (despite the

fact that a large part of GM’s market value was accounted by its GMH holding).

GM has engaged in some restructuring of Hughes other than spinoff, including a sale of Hughes’

defense assets to Raytheon and a swapping of GM shares for GMH shares. In the sale of assets, GM and

GMH shareholders argued over the structure of the deal and the distribution of the proceeds:

GM is moving to reassure shareholders of its Class H stock – tied to the earnings of itsHughes Electronics unit – that they will be adequately compensated in the recentlyannounced sale of Hughes’ defense arm to Raytheon Corp. As recently as yesterday, topHughes officials were holding conversations with Wall Street analysts and others aboutthe implications of the deal. The concern of some shareholders is that GM has crafted thetransaction in a way to avoid paying them the 20% recapitalization premium in GM’scorporate charter. GM says its board wouldn’t approve a premium and points out that lastyear’s spinoff of its Electronic Data Systems unit didn’t include such a payment. “We’recontinuing our dialogue to make sure everyone understands how this transaction isstructured,” said a GM spokeswoman. She added that GM’s board had to structure thecomplex deal to balance the interests of all shareholders. (Source: Wall Street Journal,January 24, 1997.)

Two firms with tracking stocks agreed to be acquired. Later, one of the deals, the acquisition of

Sprint by WorldCom, failed to win regulatory approval. An interesting question concerns how the

23

acquisition premium was shared between the TR and GD shareholders. In the case of Sprint, the TR stock

responded more favorably than the GD stock. In the case of TCI’s acquisition by AT&T, the GD and one

of the TR stocks (Liberty Media Group) earned similar market-adjusted returns of 7.80 and 8.28 percent.

However, another TR stock, the Ventures Group, earned 15.53 percent. As part of the merger, the

Ventures Group shares were exchanged for Liberty Media Group shares.

The last instance in Table 7 highlights the complex issues that firms with a tracking stock

structure face when they are the acquirers. Genzyme acquired Biomatrix and allocated it to one of its TR

stocks. To pay for the deal, Genzyme issued new debt that became a source of conflict between the

different classes of shareholders. The dispute arose from the fact that the debt would be a general

corporate liability. Recall that despite the separated TR and GD stocks the firm remains one legal entity.

Both stocks are junior claims, and as such both classes of shareholders bear the deal’s downside risk.

However, if everything goes well, the upside is captured only by the associated TR shareholders. These

concerns were highlighted in the following report:

Genzyme shareholders are mulling over the creation of a new tracking stock that wouldresult from an acquisition proposed by management. Two of the Genzyme Corporation’sunits covered by tracking stocks would buy the company, Biomatrix, using moneyborrowed by the parent Genzyme. While the purchase could increase the market prices ofthe tracking stocks, which are to be combined, the liability for the loan would ultimatelyfall on the parent company, leaving it to shoulder most of the risk yet receive little of thebenefit. B. Kenneth West, senior consultant for corporate governance at TIAA/CREF anda director at Motorola, questions whether investors holding tracking stocks reallyunderstand what they own. “I’ll bet the shareholders in these things don’t know if they’reon foot or horseback,” he said. “But the main drawback in tracking stocks is that theycreate significant potential conflicts of interest among stockholders, the board of directorsand management.” (Source: New York Times, December 12, 2000.)

Following this report, GENZL and GZMO (both TR) stocks appreciated by 2.63 and 12.51 percent, while

the GENZ (GD) stock declined by 6.21 percent.

Overall, the evidence of this section suggests that firms adopting a tracking stock structure often

realize that it can create substantial conflicts of interest between the different classes of shareholders.

Attempts to eliminate this structure typically result in positive returns to all shareholders.

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6. Conclusion

There has been a large increase in divestiture activity in the U.S. economy during the last decade.

Companies have been divesting businesses that are unrelated to their core businesses at a record pace.

Usually these divestitures take the form of asset sales, spinoffs, and carveouts. Tracking stocks are the

latest addition to the list and may be thought of as pseudo divestitures. The existing stock of a diversified

firm is split into two or more stocks that track the performance of different divisions. However, the firm

continues to operate as one entity. This paper examines the long-term market performance of this unique

restructuring that separates the stocks without separating the businesses.

We examine the market performance of every tracking stock issued in the U.S. market during

1984-1998 by using returns data through December 2000. We find that the tracking stocks are announced

after a period of poor stock performance. If the restructuring is an attempt to correct poor stock

performance, then one would expect an increase in firm value on the announcement of tracking stocks,

assuming that the market reacts immediately, or over a period of a few years after the issuance of tracking

stocks, assuming that the market reacts slowly. Previous literature has established that the announcements

of tracking stocks result in positive excess returns. This paper shows that the GD stocks earn largely

insignificant buy-and-hold excess returns between the announcement and issue dates and over a three-

year period after the issue date. However, the TR stocks earn significantly negative returns during this

three-year period. The poor long-term returns correspond to poor earnings performance as measured by

the short-term earnings announcement-period returns.

We directly examine a frequent explanation given for why the tracking stocks may increase the

combined firm value. It is argued that the tracking stocks increase firm transparency, which would imply

more accurate analyst earnings forecasts after the track. Our evidence is inconsistent with this argument.

On average, there is no evidence that the post-issue GD stocks are more transparent than the pre-

announcement GD stocks, and there is some evidence that the post-issue TR stocks are less transparent

than the pre-announcement GD stocks. Our last investigation focuses on the subsequent restructuring of

TR stocks. We find that in a large number of cases the tracking stock structure is eliminated by

exchanging the TR stock for the GD stock, selling the TR assets, or spinning off the TR stock. The

25

investors, analysts, and press reporters react positively to the announcement of such events. Further

analysis suggests that in many cases this positive reaction is a relief over the elimination of confusion and

conflicts of interest between the TR and GD shareholders.

The long-term market performance of tracking stocks contrasts this new form of equity

restructuring with spinoffs and carveouts. Previous literature shows that the market performance of

newly-created firms by spinoff exceeds benchmarks, and that the market performance of newly-created

firms by carveout is comparable to benchmarks. In conclusion, our evidence suggests that restructuring by

tracking stocks is not in the interests of shareholders. Managers should consider other forms of divestiture

or more carefully weigh the costs and benefits of tracking stocks in their specific situation.

26

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Table 1

Sample distribution and market values of firms that issued tracking stocks during 1984-1998.

The sample of tracking stocks is obtained from Billett and Mauer (2000) and D’Souza and Jacob (2000). It includesall of the tracking stocks issued in the U.S. market during 1984-1998. After issue, the firms have two classes ofstocks: GD, the general division stock, and, TR, the tracking stock. There is only one GD stock, but there may beone or more TR stocks. In the singular case of Fletcher Challenge Group, there are four comparable-size stocks afterthe issue date of March 25, 1996, which are all classified as TR stocks. Eight firms in our sample issued trackingstocks once during the sample period (Ralston Purina Group, CMS Energy Corp., US West Inc., Inco Ltd., ConectivInc., Georgia Pacific Corp., Circuit City Stores Inc., and Sprint Corp.). Six firms issued tracking stocks twice(General Motors Corp., USX Marathon Group, Pittston Company, Fletcher Challenge Group, Genzyme Corp., andTCI Inc.). The market value of both the GD and the TR stocks is calculated by multiplying the first closing priceafter issue by the number of shares outstanding. The motivations for issuing tracking stocks are obtained fromvarious media reports, and the insider ownership data are obtained from the first proxy statement available after theissue date.

Year 1984 1985 1991 1992 1993 1994 1995 1996 1997 1998

Number

of firms 1 1 1 1 3 1 3 3 3 3

of TR stocks issued 1 1 1 1 3 1 3 5 3 3

Variable Mean Minimum Median Maximum

Market value of GD stocks (in million dollars) 8,086 46 5,363 25,721

Market value of TR stocks (in million dollars) 1,612 16 436 9,016

Ratio of TR to GD market values 0.237 0.007 0.145 1.016

Proportion of TR stocks created via merger 29%

Proportion of TR stocks in same industry as GD 29%

Proportion of TR stocks that partition firms into growth and value divisions

39%

TR insider holdings 3.1% 0.0% 0.8% 15.9%

GD insider holdings 2.8% 0.1% 0.9% 15.6%

Ratio of TR to GD insider holdings 5.36 0.00 1.01 54.00

Table 2

Buy-and-hold excess returns (BHERs) of GD (general division) and TR (tracking) stocks issued during 1984-1998.

Our sample includes all of the tracking stocks issued in the U.S. market during 1984-1998. The BHERs arecalculated three different ways. The first procedure subtracts the cumulative market returns from the cumulativestock returns over the concerned holding period. The market returns are measured by the CRSP value-weightedreturns including dividends (VWRETD). The second procedure subtracts the relevant industry returns from stockreturns. The industry group is identified by using the Media General Financial Services (MGFS) data retrieved fromthe web site moneycentral.msn.com. The MGFS classification uses 215 industry groups, and it provides moreaccurate industry classification than CRSP or Compustat SIC codes as explained in the text. MGFS provides value-weighted industry indexes that exclude dividends, from which we calculate returns. The third procedure subtractsthe appropriate size and exchange-based decile returns from stock returns. The decile returns are obtained from theCRSP files and include dividends. In all cases, the post-issue holding period stops on the third anniversary of theissue date, the date the TR stock is sold or spun off, or December 31, 2000, whichever comes first. The pre-announcement returns are computed over a one-year period ending 3 days before announcement date, the pre-issuereturns are computed from 3 days before the announcement date to the issue date, and the first, second, and third-year returns are computed over one-year periods starting with the issue date. The mean, the t-statistic, the median,and the frequency of positive vs. negative BHERs are all calculated from the cross-sectional distribution of returndifferences. The notations *, **, and *** denote statistical significance at the 10, 5, and 1 percent level.

Description GD stocks TR stocks

Mean t-statistic Median

Frequencytotal andpositive Mean t-statistic Median

Frequencytotal andpositive

Panel A: Buy-and-hold stock returns (unadjusted)

Pre-announcement 0.67 ( 0.13) -4.37 18 8Pre-issue 17.29 ( 2.96) *** 14.18 18 14 ***

First year 19.09 ( 2.17) ** 6.67 19 12 28.00 ( 1.48) 3.62 28 16Second year 16.76 ( 1.61) 19.21 19 11 14.09 ( 1.21) 11.29 28 15Third year 23.79 ( 2.20) ** 19.10 17 12 ** -7.52 (-0.82) -19.06 25 9

Cumulative two years 35.66 ( 2.41) ** 40.10 19 14 ** 28.14 ( 2.06) ** 19.89 28 16Cumulative three years 54.17 ( 3.44) *** 42.60 19 14 ** 20.93 ( 1.32) 12.36 28 15

Panel B: Market-adjusted BHERs

Pre-announcement -16.14 (-3.91) *** -13.61 18 4 ***Pre-issue 2.69 ( 0.49) -3.43 18 8

First year 1.07 ( 0.11) -10.86 19 6 9.74 ( 0.52) -13.70 28 12Second year -3.53 (-0.36) -10.68 19 7 -7.51 (-0.59) -20.15 28 10Third year 11.03 ( 1.12) -1.32 17 8 -20.79 (-2.26) ** -27.34 25 6 ***

Cumulative two years -5.77 (-0.39) -8.51 19 8 -15.26 (-1.00) -31.45 28 7 ***Cumulative three years -4.15 (-0.26) -7.11 19 9 -40.05 (-2.17) ** -52.81 28 8 **

Panel C: Industry-adjusted BHERs

Pre-announcement -4.35 (-1.39) -4.22 18 7Pre-issue 11.34 ( 2.11) ** 2.41 18 12

First year -2.79 (-0.38) 0.66 19 10 3.91 ( 0.28) -4.64 28 13Second year 0.61 ( 0.12) -5.52 19 9 -4.68 (-0.57) -7.42 28 10Third year 9.70 ( 1.38) 1.35 17 9 -9.99 (-1.45) -9.55 25 8 **

Cumulative two years -7.84 (-0.76) -6.81 19 7 -21.12 (-1.95) * -28.95 28 7 ***Cumulative three years -4.86 (-0.47) 2.26 19 11 -28.41 (-2.31) ** -28.32 28 7 ***

Panel D: Size and exchange decile adjusted BHERs

Pre-announcement -16.57 (-3.84) *** -16.25 18 2 ***Pre-issue 1.74 ( 0.34) -1.98 18 8

First year 0.16 ( 0.02) -9.20 19 7 11.72 ( 0.62) -8.13 28 12Second year -2.08 (-0.20) -12.95 19 7 -4.80 (-0.43) -13.03 28 11Third year 12.79 ( 1.38) 8.47 17 9 -13.19 (-1.61) -21.67 25 8 **

Cumulative two years -6.01 (-0.50) -7.30 19 8 -10.63 (-0.87) -27.89 28 10Cumulative three years -0.96 (-0.07) 0.97 19 10 -23.76 (-1.85) * -29.16 28 7 ***

Table 3

Buy-and-hold excess returns (BHERs) of each GD and TR stock issued during 1984-1998.

Our sample includes all of the tracking stocks issued in the U.S. market during 1984-1998. The BHERs are calculated three different ways. The first procedure subtractsthe cumulative market returns from the cumulative stock returns over a three-year holding period after issue. The holding period stops on the date the TR stock is sold orspun off, or December 31, 2000, if either comes before three years. The market returns are measured by the CRSP value-weighted returns including dividends(VWRETD). The second procedure subtracts the relevant industry returns from stock returns. The industry group is identified by using the Media General FinancialServices (MGFS) data retrieved from the web site moneycentral.msn.com. The MGFS classification uses 215 industry groups, and it provides more accurate industryclassification than CRSP or Compustat SIC codes as explained in the text. MGFS provides value-weighted industry indexes that exclude dividends, from which wecalculate returns. The third procedure subtracts the appropriate size and exchange-based decile returns from stock returns. The decile returns are obtained from theCRSP files and include dividends. In all cases, the holding period stops on the third anniversary of the issue date or December 31, 2000, whichever comes first.

Three-year returns

Company name Ticker TypeIssuedate Industry Raw

Marketadjusted

Industryadjusted

Size decadjusted

General Motors GM GD 841105 Auto manufacturers – major -2.68 -59.25 -61.32 -70.92General Motors – EDS GME TR 841105 Information technology services 65.40 8.83 -15.67 -3.45

General Motors GM GD 851231 Auto manufacturers – major 42.60 5.29 -77.12 0.97General Motors – EDS GME TR 851231 Information technology services 12.00 -25.31 -1.84 -29.63General Motors – Hughes GMH TR 851231 Communication equipment 37.53 0.22 42.52 -4.10

USX Marathon Group MRO GD 910507 Oil and gas refining and marketing -29.28 -61.16 -21.71 -51.66USX US Steel Group X TR 910507 Steel and iron 55.64 23.76 16.64 14.14

USX Marathon Group MRO GD 920925 Oil and gas refining & marketing 21.70 -32.69 10.65 -25.68USX US Steel Group X TR 920925 Steel and iron 36.99 -17.40 -17.77 -17.42USX Delhi Group DGP TR 920925 Oil and gas pipelines -32.34 -86.73 -63.65 -85.33

Ralston Purina Group RAL GD 930802 Food – major diversified 40.10 20.21 15.02 18.33Continental Baking Group CBG TR 930802 Processed and packaged food -49.12 -69.01 -36.26 -64.61

Pittston – Services Group PZS GD 930806 Wtd avg of PZB and PZX below 93.08 38.95 9.83 55.96Pittston – Minerals Group PZM TR 930806 Industrial metals and minerals -23.32 -77.45 -43.96 -52.01

Pittston – Brinks Group PZB GD 960131 Security and protection services 16.09 -79.27 15.98 -18.15Pittston – Minerals Group PZM TR 960131 Industrial metals and minerals -83.39 -178.75 -41.83 -117.92Pittston – BAX Group PZX TR 960131 Air delivery and freight services -41.69 -137.05 -118.30 -84.54

Fletcher Challenge – Ordinary Div FLC GD 931213 Wtd avg of FLB, FEG, and FLP below 52.72 8.53 26.99 12.26Fletcher Challenge – Forests Div FFS TR 931213 Paper and paper products -15.03 -59.22 -49.16 -55.49

Fletcher Challenge – Forests Div FFS TR 960325 Paper and paper products -66.99 -157.34 -76.49 -92.28Fletcher Challenge – Building Div FLB TR 960325 General building materials -41.13 -131.48 -69.10 -66.42Fletcher Challenge – Energy Div FEG TR 960325 Oil and gas drilling and exploration -3.39 -93.74 -10.90 -28.68Fletcher Challenge – Paper Div FLP TR 960325 Paper and paper products -67.24 -157.59 -76.74 -92.53

Genzyme Corp – General Div GENZ GD 941216 Biotechnology 107.58 -7.11 25.76 -24.14Genzyme Corp – Tissue Repair GENZL TR 941216 Biotechnology 48.67 -66.03 -33.15 -36.01

Genzyme Corp – General Div GENZ GD 981116 Biotechnology 105.66 84.11 -91.79 74.35Genzyme Corp – Tissue Repair GENZL TR 981116 Biotechnology 12.72 -8.77 -184.73 -21.56Genzyme Corp – Molecular Oncology GZMO TR 981116 Biotechnology 41.34 19.79 -156.11 11.35

CMS Energy Corp CMS GD 950721 Diversified utilities 96.12 -12.89 65.38 19.01CMS Energy – Consumer Gas Div CPG TR 950721 Oil and gas pipelines 62.62 -46.39 -23.49 -6.32

Tele Communications Inc. TCOMA GD 950811 CATV systems 106.99 19.14 -8.10 7.03TCI – Liberty Media Group LBTYA TR 950811 CATV systems 236.62 148.77 121.53 136.66

Tele Communications Inc. TCOMA GD 970917 CATV systems 236.37 207.19 59.35 134.08TCI – Liberty Media Group LBTYA TR 970917 CATV systems 183.46 154.28 6.44 97.53TCI – Ventures Group TCIVA TR 970917 Wireless communications 166.65 137.47 93.73 80.45

US West Inc. USW GD 951101 Telecom services – domestic 100.02 13.92 41.63 -0.73US West Inc. – MediaOne Group UMG TR 951101 CATV systems 84.79 -1.31 -2.69 -15.96

Inco Ltd. N GD 960909 Industrial metals and minerals -28.03 -123.52 1.14 -129.67Inco Ltd. – Class VBN Shares NVB TR 960909 Industrial metals and minerals -68.84 -164.33 -39.67 -94.27

Conectiv Inc. CIV GD 980302 Diversified utilities 11.22 -15.73 -1.53 7.47Conectiv Inc. – Class A CIVA TR 980302 Diversified utilities -50.07 -77.02 -62.82 -53.84

Georgia Pacific Corp GP GD 971217 Lumber, wood production -13.45 -51.57 2.26 -55.20Georgia Pacific Corp – Timber Group TGP TR 971217 Lumber, wood production 35.04 -3.08 50.75 12.21

Circuit City Stores Inc. CC GD 970203 Electronic stores 115.29 26.76 -80.56 88.02Circuit City Stores – CarMax Group KMX TR 970203 Auto dealerships -92.31 -180.84 -17.13 -119.93

Sprint Corp FON GD 981124 Diversified communication services -42.89 -59.84 -24.13 -59.50Sprint Corp – PCS Group PCS TR 981124 Wireless communication 141.30 124.35 14.35 124.69

Table 4

Cross-sectional patterns in the buy-and-hold excess returns (BHERs) of TR stocks issued during 1984-1998.

Our sample includes all of the tracking stocks issued in the U.S. market during 1984-1998. The BHERs arecalculated three different ways. The first procedure subtracts the cumulative market returns from the cumulativestock returns over the concerned holding period. The market returns are measured by the CRSP value-weightedreturns including dividends (VWRETD). The second procedure subtracts the relevant industry returns from stockreturns. The industry group is identified by using the Media General Financial Services (MGFS) data retrieved fromthe web site moneycentral.msn.com. The MGFS classification uses 215 industry groups, and it provides moreaccurate industry classification than CRSP or Compustat SIC codes as explained in the text. MGFS provides value-weighted industry indexes that exclude dividends, from which we calculate returns. The third procedure subtractsthe appropriate size and exchange-based decile returns from stock returns. The decile returns are obtained from theCRSP files and include dividends. In all cases, the holding period stops on the third anniversary of the issue date, thedate the TR stock is sold or spun off, or December 31, 2000, whichever comes first. For means, significance levelsare based on t-statistics, and differences in means are based on t-statistics assuming equal variances across groups.Univariate median tests are based on Wilcoxin sign rank statistics and difference in medians significance levels arebased on Wilcoxon rank sums test statistics. The notations *, **, and *** denote statistical significance at the 10, 5,and 1 percent level.

Mean 3-year BHER Median 3-year BHER

NMarketadjusted

Industryadjusted

Sizeadjusted

Marketadjusted

Industryadjusted

SizeAdjusted

Panel A: Above vs. below median market value of TR stock (adjusted to 2000 dollars).Above median 14 9.17 13.45 9.08 -0.54 2.30 -3.78Below median 14 -89.27*** -70.28*** -56.60*** -82.09*** -56.40*** -60.05***Difference 98.44*** 83.73*** 65.68*** 81.55*** 58.70*** 56.27**

Panel B: Above vs. below median ratio of market value of TR to GD.Above median 12 9.39 2.96 9.88 -2.20 1.87 -1.88Below median 12 -57.83*** -49.82** -41.99*** -56.21** -37.97** -32.82***Difference 67.22* 52.78* 51.87* 54.01 39.84* 30.94

Panel C: TR stocks of firms with negative vs. positive industry-adjusted returns the year prior to announcement.GD<0 15 -23.57 -39.83** -18.31 -17.40 -33.15** -21.56GD>0 8 -21.06 10.53 -6.90 -14.20 -2.26 -11.14Difference -2.51 -50.36* -11.41 -3.20 -30.89 -10.42

Panel D: TR stock partitions firm into growth and value divisions vs. both in same category.Growth vs. Value 11 14.00 4.93 11.97 0.22 -1.84 -4.10Others 17 -75.02*** -49.99*** -46.88*** -69.01*** -39.67*** -53.82***Difference 89.02** 54.92** 58.85** 69.23** 37.83** 49.72*

Panel E: GD and TR in same industry vs. different industries.Same industry 8 0.45 -37.22 6.51 -5.93 -36.41 -5.11Diff. Industry 20 -56.25** -24.89** -35.87** -64.12** -20.63** -40.82***Difference 56.70 -12.33 42.38 58.19 -15.78 35.71

Panel F: Merger related TR stocks vs. others.Merger related 8 -39.08 -56.43* -28.94** -17.04 -36.41* -25.60**Others 20 -40.44 -17.20 -21.69 -64.12* -20.63 -40.35Difference 1.36 -39.23 -7.25 47.08 -15.78 14.75

Panel G: TR stocks with insider holdings of GD less than insider holdings of TR vs. others.GD < TR 12 -28.60 -21.09 -21.06 -17.04 -25.96 -25.60GD > TR 12 -19.84 -25.77 -11.05 -31.90 -20.63 -11.87Difference -8.76 -4.68 -10.01 14.86 -5.33 -13.73

Panel H: Above vs. below median percentage of TR shares held by insiders.Above median 14 -18.62 -28.51 -11.84 -17.04 -34.70 -25.60Below median 14 -61.48** -28.32** -35.68** -68.12** -20.63** -41.25**Difference 42.86 0.19 23.84 51.08 -14.07 15.65

Panel I: 1 indicates that the TR stock is a member of the panel's top group and 0 indicates membership in thebottom group. A blank indicates that the TR was not included in either group due to data limitations

TR Ticker Date Panel A Panel B Panel C Panel D Panel E Panel F Panel G Panel HGME 841105 1 0 1 1 0 1 1 1GME 851231 1 0 0 1 0 1 1 1GMH 851231 1 0 0 1 0 1 0 0X 910507 1 1 1 0 0 0 1 0X 920925 1 1 1 0 0 0 0 0DGP 920925 0 0 1 0 0 0 0 0CBG 930802 0 0 1 0 0 0 1 1PZM 930806 0 0 1 1 0 0 1 1PZM 960131 0 0 1 1 0 0 1 1PZX 960131 0 1 1 1 0 0 1 1FFS 931213 0 1 0 0 0 0 0FFS 960325 0 0 0 0 0FLB 960325 0 0 0 0 0FEG 960325 0 0 0 0 0FLP 960325 0 0 0 0 0GENZL 941216 0 0 1 0 1 1 0 1GENZL 981116 0 0 1 0 1 1 1 1GZMO 981116 0 0 1 0 1 1 0 1CPG 950721 0 0 0 0 0 0 0 0LBTYA 950811 1 1 0 1 1 0 1 1LBTYA 970917 1 1 1 1 1 0 0 1TCIVA 970917 1 1 1 1 0 0 1 1UMG 951101 1 1 0 1 0 0 1 0NVB 960909 1 0 0 0 1 1 1 1CIVA 980302 1 1 0 0 1 1 0 0TGP 971217 1 1 0 0 1 0 0 1KMX 970203 1 1 1 0 0 0 0 0PCS 981124 1 1 1 1 0 0 0 0

Table 5

Excess returns around earnings announcements of TR and GD stocks issued during 1984-1998.

Our sample includes all tracking stocks issued in the U.S. market during 1984-1998. For each GD stock we identifythe earnings announcement dates during the one year before the announcement date of tracking stock issue, and foreach GD and TR stock we identify the earnings announcement dates during the three years after the issue date. Thepost-issue period stops on the date the TR stock is sold or spun off or December 31, 2000, if either comes beforethree years. The earnings announcement dates are obtained from Compustat, First Call, or Lexis/Nexis (in thatorder), and are sometimes unavailable. Earnings announced within the first 63 trading days of tracking stock issueare classified as quarter +1, within 64 to 126 trading days as quarter +2, etc. Excess returns are computed bysubtracting the market returns from the stock returns over a three-day period centered on the announcement date.Market returns are measured by the CRSP value-weighted returns. The t-statistics are computed by using the cross-sectional distribution of excess returns, and are reported in parentheses. The z-statistics are obtained from thefrequency of positive and negative excess returns. The notations *, **, and *** denote statistical significance at the10, 5, and 1 percent level.

Panel A: Pooling all quarters before announcement or after issue

Earnings announcement period excess returnsType ofstock Time period

Number ofearnings

announcementsMean

(t-statistic) MedianFraction positive

(z-statistic)GD Four quarters preceding the

announcement of tracking stocks 72 0.57

( 1.20) 0.51 0.58

(1.41)

GD Twelve quarters after the issueof tracking stocks

193 -0.08(-0.26)

-0.02 0.49(-0.07)

TR Twelve quarters after the issueof tracking stocks

261 -0.94(-2.46) **

-0.81 0.41(-2.79) ***

Panel B: For each quarter separately

Earnings announcement period excess returns ofGD stocks

Earnings announcement period excess returns ofTR stocks

Quarter Number Mean Fraction positive Number Mean Fraction positive -4 17 0.43 0.65

-3 20 0.52 0.45

-2 16 -0.46 0.56

-1 19 1.62 ** 0.68

+1 14 1.47 0.43 18 0.72 0.44

+2 20 0.88 0.60 25 -1.70 * 0.32 **

+3 19 -0.97 0.47 25 -1.75 0.40

+4 19 -0.30 0.42 28 0.42 0.43

+5 15 -0.39 0.40 19 0.02 0.63

+6 19 -0.36 0.47 28 -1.37 0.39

+7 18 -0.00 0.61 22 -0.69 0.36

+8 16 -0.66 0.44 24 -1.14 0.38

+9 12 -0.69 0.33 14 -0.95 0.50

+10 16 0.64 0.56 23 -3.99 *** 0.30 **

+11 12 0.77 0.75 ** 14 2.35 0.72

+12 13 -1.38 0.46 21 -1.44 0.29 **

Table 6

Earnings transparency of pre-announcement GD stocks vs. post-issue GD and TR stocks issued during 1984-1998.

Our sample includes all of the tracking stocks issued in the U.S. market before 1998. We obtain the analyst forecastdata from First Call, and the earnings announcement dates from Compustat, First Call, and Lexis/Nexis (in thatorder). Forecast errors are the difference between the actual earnings per share and the mean forecast scaled by thestock price on the first day of the month of forecast. The standard deviation of forecasts is the standard deviation ofindividual analyst forecasts divided by the stock price. Announcement returns are computed by subtracting themarket returns from the stock returns over a three-day period centered on the earnings announcement date. Marketreturns are measured by the CRSP value-weighted returns. Pre-announcement figures are based on the four quarterlyearnings announcements before the announcement of the tracking stock, and post-issue figures are based on the fourquarterly earnings announcements after the issuance of the tracking stock. The notations *, **, and *** denotestatistical significance at the 10, 5, and 1 percent level.

GD pre-announce-

mentGD post-

issue

Difference:GD post vs.

GD preTR post-

issue

Difference:TR post vs.

GD preStandard deviation of forecast errors

Mean 0.0031 0.0031 -0.0001 0.0152 0.0142Number positive 4 8***Number of observations 13 8

Standard deviation of forecastsMean 0.0024 0.0021 -0.0003 0.0072 0.0046**Number positive 3* 9***Number of observations 14 9

Standard deviation of announcement returnsMean 3.31 3.51 0.20 5.17 1.66Number positive 12 13Number of observations 18 23

Table 7

Market reaction to the announcement of second events after the issuance of tracking stocks.

For each TR stock issued during 1984-1998, we examine media reports through December 2000 to uncover subsequent announcements that would result in removal ofthe TR stock or sale of assets associated with the TR stock. The announcements are classified into the four panels shown below. Excess returns are computed bysubtracting the market returns from the stock returns over a three-day period centered on the announcement (publication) date. Market returns are measured by theCRSP value-weighted returns.

Announcementdate TR stock name Symbol

Excessreturn GD stock name Symbol

Excessreturn

Panel A. Elimination of TR stock through retirement

19990909 CMS Energy – Consumer Gas Div CPG 14.17 CMS Energy Corp CMS -1.27

19991206 Pittston – Minerals Group PZM 49.16 Pittston – Brinks Group PZB 19.62Pittston – BAX Group PZX 10.05

19991206 Fletcher Challenge – Forests Div FFS 5.89Fletcher Challenge – Building Div FLB 17.58Fletcher Challenge – Energy Div FEG 11.69Fletcher Challenge – Paper Div FLP 15.72

20000906 Inco Ltd – Class VBN Shares NVB 27.98 Inco Ltd N 3.85

Average 19.03a Average 7.40

Panel B. Elimination of TR stock through asset sale

19950106 Continental Baking Group (sold) CBG -9.66 Ralston Purina Group (not sold) RAL 0.85

19971022 USX Delhi Group (sold) DGP 19.80 USX Marathon Group (not sold) MRO 3.69USX US Steel Group (not sold) X 3.78

Average 4.64 Average 2.27

Panel C. Elimination of TR stock through spinoff

19950807 General Motors – EDS GME 7.33 General Motors GM -1.53General Motors – Hughes GMH -2.27

19971027 US West Inc – MediaOne Group UMG 3.99 US West Inc USW 4.14

Average 3.02 Average 1.31

Panel D. Miscellaneous

19980624 TCI – Liberty Media Group (acquired) LBTYA 8.28 Tele Communications Inc (acquired) TCOMA 7.80TCI – Ventures Group (acquired) TCIVA 15.53

19990924b Sprint Corp – PCS Group (not clear) PCS 8.24 Sprint Corp (acquired) FON 0.27

19970108 General Motors – Hughes GMH 4.99 General Motors GM -1.10(Sale of defense assets to Raytheon)

19980602 General Motors – Hughes GMH -7.47 General Motors GM 5.38(Chairman announced spinoff not planned)

20000202 General Motors – Hughes GMH -4.55 General Motors GM -1.42(Offer to swap some GM shares for GMH shares)

20001212 Genzyme Corp – Tissue Repair GENZL 2.63 Genzyme Corp – General Div GENZ -6.21Genzyme Corp – Molecular Oncology GZMO 12.51Acquisition of new company by TR resulting in new TR

a The t-statistics for the average returns are given in parentheses as follows: 19.03 (3.90), 7.40 (1.18), 4.64 (0.54), 2.27 (1.60), 3.02 (1.07), and 1.31 (0.46). The first ofthese t-statistics is significant at the one percent level, the others are insignificant (due to the small number of observations).b The acquisition of Sprint Corp was announced on this date, but it was never completed. Whether the PCS Group would be acquired was not clear on this date.

Appendix 1

Additional evidence on market performance of tracking stocks with recent issues.

We present additional evidence on the BHERs of GD and TR stocks issued between January 1999 andApril 2000. Year 1999 saw an unprecedented increase in the popularity of tracking stocks, with six firmschoosing this form of equity restructuring. Year 2000 saw the biggest TR stock issue, in fact the biggestever stock issue, that was linked to the wireless communications business of AT&T Corp. The combinedsample during this period includes seven firms, but only six GD and eight TR stocks. In all cases exceptone, we can identify one stock as the GD stock, which is usually bigger than the TR stock and has a pricehistory starting from before the issue date. However, in the case of Quantum Corp., the old stock wasentirely replaced by two new stocks of comparable size that are both classified as TR stocks.

Table A.1 shows that six out of eight TR stocks earn negative raw returns and negative BHERs using allthree benchmarks. Only one TR stock – Celera Genomics Group – earns positive BHERs using all threebenchmarks. The average market-adjusted, industry-adjusted, and size-adjusted BHERs equal -19.70,-36.19, and -31.63 percent, negative but insignificant, perhaps due to the small sample size. This newevidence looks similar to the old evidence in Table 2. Finally, the BHERs of GD stocks created during1999-2000 are positive but insignificant.

Table A.1

Buy-and-hold excess returns (BHERs) of GD and TR stock issued during January 1999-April 2000.

This table shows the sample of tracking stocks issued in the U.S. market during January 1999-April 2000. This sample is not merged with the primary sample presentedin all other tables, because the measurement period for BHERs is rather small. The BHERs are calculated three different ways. The first procedure subtracts thecumulative market returns from the cumulative stock returns over a holding period that stops on the date the TR stock is sold or spun off or December 31, 2000,whichever comes first. The market returns are measured by the CRSP value-weighted returns including dividends (VWRETD). The second procedure subtracts therelevant industry returns from stock returns. The industry group is identified by using the Media General Financial Services (MGFS) data retrieved from the web sitemoneycentral.msn.com. The MGFS classification uses 215 industry groups, and it provides more accurate industry classification than CRSP or Compustat SIC codes asexplained in the text. MGFS provides value-weighted industry indexes that exclude dividends, from which we calculate returns. The third procedure subtracts theappropriate size and exchange-based decile returns from stock returns. The decile returns are obtained from the CRSP files and include dividends. The mean and the t-statistic are calculated from the cross-sectional distribution of return differences.

BHERs

Company name Ticker TypeIssuedate

Lastdate Industry Raw

Marketadjusted

Industryadjusted

Size decadjusted

Ziff-Davis, Inc. ZD GD 990331 000922 Publishing – periodicals -48.35 -69.36 -33.57 -69.77ZDNet Group ZDZ TR 990331 000922 Internet software & services -53.48 -74.49 -57.25 -68.89

Applied Biosystems Group ABI GD 990506 001231 Scientific & Technical Instruments 256.41 253.62 154.36 241.92Celera Genomics Group CRA TR 990506 001231 Scientific & Technical Instruments 239.97 237.18 137.93 224.88

Donaldson, Lufkin & Jenrette, Inc. DLJ GD 990526 001103 Investment brokerage – national 34.02 19.10 8.03 24.77DLJDirect, Inc. DIR TR 990526 001103 Internet software & services -82.92 -97.84 -70.36 -93.98

Quantum Corp – Hard Disk Drive Group HDD TR 990802 001231 Data storage devices 18.51 15.68 -80.58 1.45Quantum Corp – DLT & Storage Sys Group DSS TR 990802 001231 Data storage devices -30.72 -33.55 -129.80 -48.24

Snyder Communications, Inc. SNC GD 991029 000926 Diversified communications 83.32 72.59 122.44 73.55CIRCLE.COM CIRC TR 991029 000926 Internet software & services -77.16 -87.89 -52.56 -116.50

Walt Disney Company DIS GD 991130 001231 Entertainment – diversified 4.50 8.34 11.27 1.76GO.COM DIG TR 991130 001231 Internet information providers -84.14 -80.30 -23.45 -106.99

AT&T Corp. T GD 000427 001231 Long distance carriers -63.45 -54.11 2.56 -62.50AT&T Wireless Group AWE TR 000427 001231 Wireless communications -45.69 -36.35 -13.42 -44.74

Mean for GD stocks(t-statistic)

44.41(0.93)

38.36(0.80)

44.18(1.44)

34.96(0.75)

Mean for TR stocks(t-statistic)

-14.45(-0.38)

-19.70(-0.51)

-36.19(-1.30)

-31.63(-0.81)

Appendix 2

Description of transactions used to eliminate TR stock

For each TR stock issued during 1984-1998, we examine media reports until December 2000 to uncoverannouncements that result in removal of the TR stock. Table 7 in the text shows the announcement datesof the following restructuring events.

Company TransactionType

Description Resulting equitystructure

CMS Energy Exchange ofTR for GDshares

CPG shares exchanged for CMS shares at 15percent premium over average pre-announcementprice during period from July 28, 1999, to August24, 1999.

Single class ofcommon stock

Pittston Exchange ofTR for GDshares

PZM and PZX shares exchanged for PZB sharesat 15 percent premium over average price over10-day period prior to announcement, December6, 2000. Following exchange, the PZB shares willrepresent company as a whole.

Single class ofcommon stock

Fletcher Combinationof methods

Sold paper division with proceeds given to FLPshareholders. Plan to sell energy division andspinoff building division, leaving forest division adistinct company.

Ongoing –expectation issingle class ofcommon stock

Inco Ltd. Tender offer Inco Ltd. Offered $7.50 in cash plus a warrant for0.45 shares of Inco Ltd. for each share of NVB.This offer was approved at a shareholder meetingafter previous tender offers resulted in too fewshares tendered. The vote, which required a 66percent majority, forced all TR shareholders toaccept the offer.

Single class ofcommon stock

Ralston Exchange ofGD for TRshares

CBG assets sold, but rather than pay out netproceeds, Ralston chose to exchange CBG sharesfor RAL shares at a 15 percent premium overperiod March 31 through April 6, 1995.

Single class ofcommon stock

USX Asset saleproceedsexchanged forTR shares

DGP assets sold. Sale proceeds net of allocateddebt and expenses exchanged for DGP shares.

One track remains:GD: MROTR: X

GM Spinoff GME shareholders receive one share of EDS foreach GME share. GM receives a one-timepayment of $500 million from EDS. GM andEDS enter into long-term business agreement.

One track remains:GD: GMTR: GMH

US West Spinoff MediaOne shares remain outstanding. New USWest shares are issued in exchange for old USWest shares. New US West retains some ofMedia Group’s assets, the “Dex” directorybusiness, in exchange for shares of New USWest. In exchange, new US West assumes $3.9billion of debt previously allocated to the MediaGroup.

Single class ofcommon stock