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Title: Unlocking Value: Equity Carve outs as Strategic Real Options

Author(s): Enrico C Perotti and Silvia Rossetto

Publication Date: April 2007

Keyword(s): Buy back, Equity carve out, Real options, Spin Off and Vertical integration

Programme Area(s): Financial Economics

Abstract: Equity carve outs, the partial listing of a corporate subsidiary, appear to be transitory arrangements, usually dissolved within a few years by either a complete sale or a buy back. Why do firms perform expensive listings just to reverse them thereafter? We interpret carve outs as strategic options to attract information from the market over the relative value of a productive unit as an independent entity and thus to improve the decision process on whether to sell out or to retain control. The separate listing is costly, as it reduces coordination of production, but generates valuable information from the market over the optimal allocation of ownership. We compute the optimal timing for the final sale or buy back decisions, the value of the strategic options embedded in the carve out and the optimal shares retained. The model explains the temporary nature of carve outs, and suggests an explanation for many empirical findings. In particular, it explains why carve outs are more common in sectors with high uncertainty and in more informative markets.

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Bibliographic Reference

Perotti, E and Rossetto, S. 2007. 'Unlocking Value: Equity Carve outs as Strategic Real Options'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=6268