REARRANGING RESIDUAL CLAIMS - A CASE FOR TARGETED STOCK

Investors who want to buy stock in a firm but only in part of it can d o so thanks to a restructuring method called Targeted Stock. This proc ess allows firms to issue different classes of stock linked directly t o the performance of their individual businesses. The phenomenon began in 1991 when USX Corporation created Marathon Group Targeted Stock fo r its oil operations and Steel Group Targeted Stock for its steel busi ness. The company then created Delphi Group Targeted Stock for its nat ural gas business in a 1992 IPO. Only a few companies have taken advan tage of this technique, but more will. Among the advantages of Targete d Stock: It keeps the firm in one piece, which can avoid taxes; preser ves its consolidated borrowing power; and retains synergy among the bu sinesses. Boards do not change, and under the right circumstances, com panies may still shift revenue from one business to support another. F irms can also raise capital cheaply by issuing shares for a business w hen it is flying high instead of floating shares in the whole corporat ion when its price may be depressed by lagging businesses. From the in vestors' standpoint, Targeted Stock makes it possible to achieve ''pur e plays'' in the specific businesses in which they prefer to invest. M eanwhile, separate dividends and financial reporting keep subsidiary m anagers on their toes. The downside is that targeted businesses are ex posed to the weaknesses of fellow businesses within the firm, top mana gement may favor one business to the detriment of another, and targete d business managers may squabble. Critics of the technique claim it is just a dodge to protect diversified corporate conglomerates from take overs while creating the illusion of restructuring. But our research s hows that the stock market seems to like Targeted Stock. We examined t welve companies that announced plans for Targeted Stock. The eight tha t got shareholder approval registered an average excess share price re turn of 2.9% above the market (Ralston Purina enjoyed a 10.4% gain) ac cumulated over the two-day period surrounding the announcement. Even i f 2.9% doesn't seem large, it is noteworthy because it is positive, an d it is comparable to the effect of other restructuring methods. For e xample, we reviewed five previous studies and found an average announc ement period excess return of only 2.9% for equity spin-offs. Targeted Stock is not a panacea. It only makes sense when equity restructuring does, and it is better than spin-offs or carve-outs only when the com pany is worth more intact than in pieces. However, our research provid es important evidence that Targeted Stock can provide an attractive op portunity for corporations and investors alike.