Risk hedging through forward supply contract and equity ownership in a spin-off decision

Risk hedging through forward supply contract and equity ownership in a spin-off decision

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Article ID: iaor2008139
Country: Netherlands
Volume: 106
Issue: 2
Start Page Number: 532
End Page Number: 543
Publication Date: Jan 2007
Journal: International Journal of Production Economics
Authors: , ,
Keywords: option pricing, Risk hedging
Abstract:

We consider the situation where a publicly traded firm is spinning off a subsidiary in order to maximize the shareholder value of the firm. To balance the underlying operational risks of the spin-off, the firm also uses a forward supply contract to hedge against the price and demand fluctuations in the future transactions of the goods produced by the subsidiary. Using an option pricing framework, we formulate a value-maximization optimization problem for selecting the best ownership structure and forward supply contract in the spin-off decision. Using our model, we present a set of numerical results to illustrate the value of a forward supply contract as an additional lever to corporate ownership structure in mitigating the operational risks induced by the underlying market uncertainty in order to maximize shareholder value. Our results provide some interesting in sights for selecting the appropriate ownership structure and forward supply contract under different operating environments in a spin-off decision.

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