Bridge over ocean
1 September 2015 CFA Institute Journal Review

Off Track: The Disappearance of Tracking Stocks (Digest Summary)

  1. Pamela G Yang, CFA, CPA, CGMA

Tracking stocks were created and dissolved within a span of two decades. At both the creation and dissolution, positive abnormal market reactions were observed. The short life of tracking stocks indicates that the tracking stock structure was not value enhancing and that the initial expected benefits proved to be unrealistic.

What’s Inside?

Tracking stocks were introduced in 1984, and despite the initial positive market reaction, studies have found long-term market underperformance after the issuance. The last new tracking stock was issued in 2001, and most of them have stopped trading by now. The authors examine why and in what ways they were dissolved. They further investigate the wealth effects caused by the two methods of dissolution: exchange of tracking shares for parent shares and sale or spinoff of the entities.

How Is This Research Useful to Practitioners?

This study is the first to focus on the dissolution of tracking stocks. Tracking stocks were intended to track the performance of a specific unit within a company. The supposed benefits included greater transparency and preserving the value of internal capital markets. Contrary to that initial belief, data from the two decades of trading show that tracking stocks provided no improvement in operational performance and that in the long run, tracking stocks underperformed. In addition, the tracking stock structure imposed complexities on the management of and reporting for conglomerates.

The authors further conclude that there is no evidence for the supposed benefits of internal capital markets. In fact, announcements of tracking share dissolution yielded consistently positive abnormal returns for both the parent company and the tracking unit. Companies with higher debt ratios benefited from eliminating tracking stocks. The abnormal returns from dissolving tracking stocks were higher for the tracking units than for the parent companies. Most tracking stocks were dissolved by a direct sale to another company or through spinoff, whereas one-third of tracking stocks were exchanged for parent company shares. Investors who owned both the parent and tracking stocks earned positive returns from the dissolution announcement, and there is no statistical support to favor one dissolution method over the other for the investors who have the dual ownership.

Tracking stocks’ short life suggests that when a new specialized equity is created, investors should use caution and special consideration should be given to the question of whether the claimed benefits outweigh the complexities.

How Did the Authors Conduct This Research?

The authors first present several case studies to analyze the reason for the creation of tracking stocks and the possible benefits. One example given is Pittston Company in the coal industry issuing tracking shares in Pittston Minerals, in its Brink’s division, and in the Burlington Business known as BAX. Similarly, the authors examine a few companies to study the process of dissolving tracking stocks. In addition, they present a table that contains a list of 21 firms that issued a total of 31 tracking stocks and that shows the year of issuance, the year of dissolution, and the dissolution method. From this dataset, they calculate the average number of years tracking stocks traded after issue and how the majority of tracking stocks were dissolved.

Next, the authors calculate cumulative abnormal returns (CARs) around the announcement of dissolution. They show the market model and value-weighted index for both parent stocks and tracking stocks. This comparison reveals that the abnormal returns for tracking stocks are higher than those for parent stocks at dissolution. To explain the market reaction, the authors present three more tables that illustrate the determinants of parent CARs and tracking CARs. They analyze four possible factors: the performance of the tracked units, the potential value of the internal capital market, the method of dissolution, and financial constraints. The final step is to examine the combined abnormal returns of parent and tracking stockholders. The authors conclude that the effect of abnormal returns is almost equivalent from dissolving by sale or spinoff of the tracking units and performing a simple and regular spinoff of the business unit.

Abstractor’s Viewpoint

History depicts an unbiased picture of the pros and cons of all new investment products. The quick dissolution of tracking stocks shows that the tracking stocks did not live up to the expectations, and both investors and companies probably could have benefited more from a regular spinoff than from creating and dissolving this unique equity structure. From this standpoint, the authors provide a good lesson on why tracking stocks stopped trading.

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