A tracking stock, also known as target stock, is a special type of equity issued by a parent company that mirrors the financial performance of a specific division or subsidiary rather than the company as a whole. By creating tracking stocks, companies can segregate the financial results of different business units, providing investors with targeted investment opportunities.
How Tracking Stocks Work
Tracking stocks function by allocating specific assets and liabilities of a parent company to the tracked division. The earnings and performance of the tracked division primarily influence the stock’s price. However, ownership rights, such as voting power and dividend claims, may differ from regular common stock.
Equation and Financial Metrics
Benefits of Tracking Stocks
Improved Focus and Transparency
Tracking stocks provide greater financial transparency and focus for both investors and the company. Investors gain a clearer view of the performance of specific business units, allowing them to make more informed decisions.
Enhanced Investor Appeal
By allowing investment in successful divisions, tracking stocks can attract more investors and potentially increase the market valuation of the company. This can also lead to higher liquidity.
Strategic Flexibility
Companies can leverage tracking stocks for strategic financial maneuvers, like funding specific division growth without diluting ownership or control over the entire firm.
Risks and Considerations
Limited Control and Voting Rights
Tracking stockholders usually have limited or no voting rights in the parent company, which may reduce their influence over corporate governance.
Inter-Division Complications
Financial interdependencies between the tracked division and the parent company can create complexities, leading to potential conflicts of interest or misalignment of incentives.
Market Perception
If the market perceives the creation of tracking stocks as a signal of underlying issues within the company, it might negatively affect investor confidence and stock valuation.
Historical Context and Examples
Notable Examples
- Liberty Media and Liberty Braves Group: Liberty Media issued tracking stocks to reflect the performance of the Atlanta Braves, aiming to highlight the team’s financial metrics independently.
- AT&T’s Early Efforts: AT&T issued tracking stocks for its wireless unit in the late 1990s, which proved successful at highlighting the financial potential of its mobile operations.
Comparisons with Similar Concepts
Spin-offs
Unlike tracking stocks, spin-offs involve creating an entirely new, independent company from the parent company’s division. Investors receive shares of the new company, and it operates independently post-spin-off.
Subsidiary IPOs
A subsidiary IPO involves selling shares of a subsidiary to the public. This provides capital but results in a degree of independence for the subsidiary, unlike tracking stocks which remain tied to the parent company.
FAQs
What voting rights do tracking stockholders have?
Are tracking stocks a common investment in today's market?
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance. McGraw-Hill Education.
- “Tracking Stock.” Investopedia. https://www.investopedia.com/terms/t/trackingstock.asp
Summary
Tracking stocks offer investors a unique way to invest in specific divisions of a company, providing greater focus and transparency. Despite the benefits, including enhanced investor appeal and strategic flexibility, they come with risks like limited control rights and potential market perception issues. Overall, tracking stocks remain a specialized financial instrument that can be highly advantageous in the right circumstances.
