Parrino marrcase

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asEwER Journal of Financial Economics 43 (1997) 241.274

Spinoffs and wealth transfers:The Marriott caseRobert Parrino

(Rcaivid Septe mber 1994: fina l version nsivcd March 1996)

This paper crtmin cs changc3 in bondhoidcr and sharettoldcr wealth result ing from the1993 Marriott spinoff. I t docum ents a wealth transfer from boodbolders to shahokkrsand a da4ine in the total value tif the firm following tbe spino tT announa ancnt. Subscqtunt m odif ications to the qind: plan rcduocd tbc bond- loss. but tbc value ofMarriotfs notes and dcbentutes remained W M.6 mihou bdow tbcir pre4anouncermzntkv d on tbc distribution date. lndrurr>.-adjusted shareh okkr gains during the sam eperiod wee only SW .6 mill ion. frzmsaa b co6ts and inctf icirncLs tesult ing from thespiaoBerplainmuchdthededincintheto(aiv~ueoltbc~Key ww & Spinoff; Restructuring Agency costs Financti policy/EL clasif icotiac G32; G34

In October 1993. Marriott Corporation distributed the equity in its managemcnt busincsscs to shareholders This spinoff reduced financial constraints thathad resulted from a deterioration in the firms pprformana durinp the early

[kta pawidcd by Hospitality Valuation Smias. Kcmpcr FinancuL fenill Lynch Smith TravelResarch. chc Univccaty of Texas System investment o&c. ud Ban Witler is gralcfutly a&now -kd@. I would like to thank David Blackwell. Kenneth Borokbovich ikad Chiquua Go&nHa&a . Mark Husan. D avid Ikcnberry. Sandy Koch, scoC1 Lee, 1. Rusdl Kamp k Rul Laur M nMartin. Lisa Meulbroek (the &nx), Rune& Rau, Ehud Rona Laun Strrks. Michael Wcisbmcb.and the editors (Richard Ruhack and Karen Wruckl for their conunatts Tbc paper abo bend itedtram comments by saninrr participants at the University of Texas. the University td Houston. andthe 1994 Financial Ma nagaunt Association Meeting.

0304-405X/97,S15.00 3 I997 Elscvicr Scicna S.A. All rights reservedP/I S0304-405X(96)00SR5-9


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242 R. Pumno ~Journo l of Financial Economic,> 43 l lW7) 241. 274

1990s. A decline in cash flows from operations and a weak market for hotelproperty sales had left Marriott with a histo rically high level ofdebt, promptingrating agencies to lower their ratings of Marriotts public notes and debenturesto the lowest investment grade. The spinoff improved the ability of the manage-ment businesses to fund new investments by limiting bondholder claims on theircash flows. However, it also left the parent with only real estate assets and therelatively small airport and highway concessions business to serv ice most of thecompanys long-term debt.The Marriott spinotT illustrates how the separation of a ftrms businessestlrough a pro rata distribution of the equity in some of those businesses cantransfer wealth among securityhoiders. This restructuring is highly unusual inthat Marriott distributed shares that represented almost 80% of the value of itsequity and substantially incmased the leverage of the parent. Previous studiessuggest that spinoff distributions typically involve shares worth only 10% of thetotal market value of the equity (Hite and Owers. 1983; Miles and Rose&l&1953) and that. on average. the kveracle of the parent changes little (Chipper.I~J CmiI+, 1?8t: T : :.I. + .U ;pr.100 hranskrrcd wealth from bondholdets toshareholders and caused the total value of the companys public securit ies todecline.

This spinoff is also noteworthy in that Marriotts bondholders were able toforce the company to alter its plans even though no provisions in the bond-holder indenture agmement prohibited the restructuring Rondhoklers initiateda coordinated eRort to block tbe spinofT almost immediately after it wasannounced in October 1992 and suaxxdai in forcing Marriott to change thestructure of the spinofTand bondholder claims in ways that reduced the magni-tude of the wealth transfer. The post-spinoff kverage of the parent was lowerthan originally anticipated by the company and bondholders emerged from thespinoff with new claims that included higher coupon payments.Tbe limits that the spinoR pkxed on bondholder claims suggest that it wasdesigned to benefit all shareholders However, the Marriott family. which owned25.8% of the common stock, benefited in ways that public shareholders did not.The spinoff reduced the likelihood that the family would lose control of themanagement businesses and much of its wealth if economic conditions con-tinued to deteriorate The spinoffalso enabled Marriott to continue to grow themanagement businesses without diluting the familys control.The paper is organized as follows. Section 2 describes !M data and methodo-logy used to measure securityholder returns An overview of Marriotts busi-nesses at tbe time of the spinotTannouncement and the pre-spin08 performanceof the firm is provided in Section 3. !kctioo 4 documen t.s how the values ofMarriotts public securities changed between the announcemen t and the distr i-bution. Section 5 discusses the effect of the spinoff on firm value and Section 6describes the be&its of the spinoff to the Marriott family. Conclusions arepresented in Section 7.


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R. Pam no Journal of F inanc ia l Economks 43 0997) 241 274 243

Closing prices from the New York Stock Exchange and bond dealer bid pricesare used to document the effect of the spinoff on the value of all of Marriottspubl icly traded securities. These securities, which had an aggregate market valueof&&232 mil liou at the end of the quarter preceding the spinoff announcement.-ted approximately 8 I % of the total value of Marriotts long-term debtand equity (Table I ). The remaining 19% consisted of S493 million in mortgagedebt, U93 million in private unsecured notu and 5290 million outstanding ona revolving line of cred;t.Daily closing price, dividend. and volume data for the common stock arefrom The Wall Stree t JOWMI and The Daily Stock Price Record. Daily market-Tabk IM~lCofpontiLmliabilllwsand~- cqluly on Scptcmbcr I I. WI? tS mrllwms)._- . ..--- ----

&d Mark4vatuc vatuc--.--- -.--.---_ -----. ..-. - . . - __ _ -.-...-...

cumo1 liabihtics 51.329scoiol tong-tmm debt

!salior oous and 6tbcntum I.872 $2.019Mortgage dkbt 493aheroots I93Rcdviog line of credit -soTotal

coavcrtlbk suboldimIai detd -% - 226ottlcl toog-tcml liabilities I.250Coourtibk pdcrd stock 200 35Cowmsoo equity and rchud earnings 516 I .7?2Total tiditks and - equity $6.425Total market uluc of public sccuritks s4 3-- ____ _ -_ _.-.____-- _.._ _,-_ __.-- -_-.The quarter immahtcly ptuaiing the spmotT an IKNowmrnI cndd on !septcmtlcr I i. 1992.mlcnrbordiaareddcbt.prrCrrreduodr.rn4 amm o0 stock valuer arc compu tal usmg cbsiogpifa~tbc~;orLStodrEsctu~onScpcemberll.l997Thc~alucdthc~iornotarnddebmum is cumpuud using de&r bid ptks for !kptcmher Ia !99L*Marriott bad I3 senior notesand dcbcnturcs outsta ndingon Septe mber Il. I992. Their boot; valutsnogal hen 599 to S250 millio n and their m8Witics hm nine months to r0 )cln.8.2% Iiquid ykkt option odes (LYONS) issad in June I991 and maturing in JUIX -X06. Frh ofI& 675.ooO LYONS um convertible into 13.277 shares of Marriott C *~rporation common stock.Includes a casualty self-insurana reserve d approximately S200 millioa . ddcrmd income d S2OitmilliondderrediaawactaxcsoC564~~iUionadot~~bilitiasucb~Jobliglionrundcr(hcfrequent stay plograol and l#&m! d colopmsation.F~rmillionshtcrdamveniMc~scod;wcre~inDaxmberIWlwithadi~ol8.25%. Each pine d share was convertibk into 2874 shares of Marriott Cupora tion comm onstock.


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244 R. Purrino/Journol of Financial Economics 43 (1997) 241 -274

adjusted common stock returns equal the excess of daily returns on Marriottscommon stock over the corresponding daily returns predicted by a marketmodel, R, = x + /lR,,,, + e,. The S&P 500 index proxies for the market portfolio.The methodology employed by Mikkelson and Ruback (1991) is used to esti-mate the market-adjusted returns over the period beginning 60 trading daysbefore the spinoff announcement (Ju ly 10.1992) and ending 60 trading days afterthe distribution (January 4.1994). Two estimated sets ofc&Ecients incorporatepotential changes in the market model parameters. The first two coefRcients, zland fl,, are estimated using daily returns over the 200 trading days ending 61trading days before the announcement. The other two coeRicients, zz and &, areestimated over the 200 trading days beginning 61 trading days after the distribu-tion. Market-adjusted returns prior to the announcement are computed using x1and /?,. while all subsequent returns are computed using zz and fi2. The marketmodel parameter estimates are as follows: zr = - 0.04. /I, = 1.3540. zz =0.0005. and /f2 = 1.5512. A Chow test does not reject the hypothesis that themodel paraak;ters are the same in the two periods (F(198.198) = 0.25).111:\ i~-y...+~-!3 ~~:rn ;, itoc h returns equal the excess of daily Marriottstock returns over the daily returns on a hotel industry index. A market modelapproach is not used to adjust the Marriott stock returns for industry changesbecause the shares of two firms in the industry index were not publ icly tradedbefore 1992 The firms in the industry index come from an initia l list of 135 publicfirms with U.S. hotel operations. The index is restricted to hotel tirms becausethere were no public firms with over 50% of their cash Rows from contract foodservias and a market value of equity exceeding SM million on October 21992The final l ist contains six firms that meet the following four criteria:I) prices for the firms shares are published in the NYSE AMEX, or OTC DoilyStock Price Record;2) the firm operates or owns at least ten hotels in at least three states and themarket value of its equity is at least S30 million on October 2. 1992 (thiscriterion excludes firms with relatively ilhquid sharesk3) a majority of the firm*s operating profits are from lodging businesses and less

than one-third of its lodging-related profits are from casino operations (thiscriterion limits the effect of non-hotel industry performana on the indexreturns); and4) the firm is not operating under Chapter I1 bankruptcy protection.

Finns with significant casino operations arccxdurkd because thctr shares genetaUy pcrfoonnad wel lduring the uurly pcriud d ue to a m in tbc caxino industry. Tbc sensitivity of the in&x rctumxto this Rztrictiom wax cxamir-4 by inclu ding two large lodg ing firms that had ban excluded bccauscot thdr casino operations: Hilto n Hotels Corporation and Promux Compa nies lttc (HarraluHam pton Inn Embassy Suites , and Hom ewood Suitex L The cumulat ive industry index rcturtxscxtirnatcd with thee tw o firms (eight firms total) are higher bevern the rnnounam cat and the


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R. PamnoiJoum al of F inanc ia l Ecunomics 43 (1997) 241-274 245

The six firms in the index are Hospitality Franchise Systems, Inc. (Days Inn,Howard Johnson, and Ramada), La Quinta Motor Inns, Inc., La Quinta MotorInns L.P., Marcus Corporation (Budgetel and full serv ice hotels), Red Lion InnsL.P., and ShoLodge, Inc. (Shoneys Inn). Daily industry index returns arecalculated as the simpk average of the stock split- and dividend-adjusted dailyreturns for the common stock of the six firms. (A value-weighted index returnfrom the annou nament to the distribution is higher than the equal-weightedindex return, suggesting that the choice of an equal-weighted index does not biastbe industry-adjusted returns downward.) The r-sta tistics for the industry-adjusted retu.ns are calculated using a methodology similar to that employedby Ritter (1991).la contrast to previous studies, which examine the relatively few d&t issuesthat are traded on the New York Exchange, this paper uses deakr bid prices todetermine changes in the value of the 13 senior note and debenture issues thatwere outstanding at the time of the spinotr announcement. These prices wereprovided by financial institutions that trade the Marriott securities, BloombergBusiness News Service. and Standard and Poors for 45 days during the periodfrom 60 trading days before the spinoIT armoulKxmen t to 60 trading days afterthedistribution.Severalso(l~werrusedb#austacompktesetoCI3priacsisden mavailable from a singk source on a given day. A comparison of bidprices from the alternative sO.rr~cs reveals no systematic di&rence& suggestingthat data from a particular source are unlike ly to bias tbe price estimates. Bid~wcrcobtainedforeachissuefordays -60. -31. -IS, -10, -5through5. IQ 15,2Q and approximately every 1 I trading days thereafter through day316(January4,1994).CMtbe143bidpr&scolkctedfortbe lldayssurroundingtbe spinoff announcemen t I36 were obtairkd from a single firm that activelytraded Marriott notes and debentures.

Al l of tbe note and de&nture prices ate adjusted to mfkct cbcnges in tna~letyields after July JO, 1992 (day -60). These adjustments are made usrng 8883industria l bond indexes reported by the Bloomherg Business News smioc.BBB3 indexes are used because they correspond to tbe credit rating of theMarriott senior notes and debentures at the time of the spinoffannouneement.Siwc Bloomberg reports only yields tar the above indexes, these yields arefirst restated as prices, indexed to a value of 10 on July 10.1992 Tbe prices forthe Marriott notes and debentures are then individually adjusted using thepercentage change in the value of the index that most closely matches thematurity of each issue. Jhis adjustment is computed using the relation

P,.i = pl.j - (P- tt0.j Afr.w). (1)

dixtribution than tbe in&x tetums estimated without than. Coarcquc13tly. the industry-adjusted~umsom the Marriott common stock are lower when Hdton and Promu: alrc included in the indexthan when they am not.


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246 R. Pam~no/Joum al of Financial Economics 43 (1997) 241-274

where Pt,j is the price of bond j on day r and AltsM is the percentage change inthe value of the index for bonds with maturity M between day -60 and day 7.The overbar indicates the adjusted value.The market-adjusted note and debenture prices are multiplied by the numberof bonds outstanding to obtain the total value of each issue. These valuesare then summed to obtain the aggregate value of the notes and debentures.An adjustment to the bond values after October I.1993 r&e& the retircmeatof $174 million of these securities with Marriott stock and cash. Aggregatebond values after this date equal the market-adjusted value of the bondsthat mained outstanding plus the market value of tbe shares that weredistributed and the value of the cash payment. The values of two notes thatmatured between the announcement and distribution dates are calculatedby assuming that the procads from their retirement are reinvested to earn8% per year. The value of a third note. which was eliminated througha defeasana 01 the di&budou date, is set equal to its faa value after thatdate.Llruly returns for the subordinated convertibk debentun5 and preferred stockare computed using closing price and dividend data reported in The Wull StreetJowrrcrl. These returns are not adjusted for market changes. Two-factor marketmodels, with ten-year BBB3 industrial bond returns and S&P 500 returns asfactors, were estimated for these securities, but have no significant explanatorypower.

In 199L Marriott had revenues of S8.7 billion and operating profits of S4%million. The lodging amnagcmetu group, which indudad hotel, timcsharc, aadgolf facility management busiaesscs contributa! 52% ($4.5 bill ion) of therevenues and 68% ($338 million) ofthe operating profits (Tabk 2). The companyowned, managed, or franch&d 746 hotels. Marriotts otbcr rcvcllues andoperating profits came from tbe contract services group. which consistai of foodservice and facilities maqprunt, airport and highway m r&ancntcommunity maniyment, and restaurant supply dis!ri+$n busiwsscs Tbcfood rmicc and facilit ies manamt bu&esq with 1992 revenue ofapproxim-atdy S3 billion, provided fimkes to a wide range ofdients induding corpora-tions health care f&ilitieq and secondary schools and colleges. Tbe Host/Travelplazas airport and highway concessions business, with revenues of SO.9 billion,Operated dons in airports, on tollroads. and in stadiums, am andotber public attractions. Tbe retirement community management and distribu-tion businesses were both rdativciy small. With two-thirds of its operating profitfrom lodging-related businesses, Marriott was generally viewed as a hotelcompany.


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R. Pam no:Joum al of Finonrial Economics 43 (1997) 241.274

Tabk 2Marriot t Corporat ion major l ines of business and 1992 operat ing prof i ts

--- _---_.--_ .__-._ __ .__ __. _ _ __._ ._. _ _ _Lodging Managem ent Group tW.5 b i l l ion in revenue)

Hot& owfck ms0ft .s and suite5Mm iou Owtcrship Resorts (timeshare)Mm iott Golf fgou faci l i ty mJnagcmcnt l

Cootract Smias Group (54.2 bi l l io o in rwcnuc)Food !krvie and Fac5litks Man agem entHost~ravel Plazas lairport and highway conassions)Marrio tt Lktribuhon !Setvices (resIaurant su pplydiSUibUl iOO)Senior Living Service tretircmcnt communiry mana gcmem tRcstaunnts

MJrriot I l l lul_-___ . --.-- _-. - .--- ._ ___ ___ . --__-__Esrion~cd from documents hkd hy Marriot t -8th the SE< .*lasufscsml btJ arc rcail iible 10 c5mlJtc lhesc VJlu K

1992opcratmg prof i t IS mi l l ions)

Percentof lOILl

312 62.9%26 5.2%Mb nab

7462

14.9?i12.Y.

2.4. .21)YkM b

1000 .

?4 7

Marriott financed most of its Lapital requirements through the sale of notesand debentures at the corporate kvel. The companys senior notes and deben-tures. which accounted for 65.7% of the senior long-term debt (Table I ). were allgeneral obl&ations of the firm. Mortgage debt totaled only $493 million(17.3%). Marriott soM virtually no equity in the 1980s and early 1990s. in fact,the company reduced the total number of common shares outstanding ffmn132.8 million in 1982 to 95.5 million in 1991 through stock repurchases.Marriott pursued ambitious growth and prditability objectives in the hotelbusiness through a strategy ofdeveloping and then selling hotels whik retainingthe right to manage them. An important financial aspect of this strategy was theseparation of property management from ownership. which cot only reducedthe amount of capital necessary to fund ragid growth but also providedMarriott with kss volatile cash flows than with direct hotel ownership. Undermanagement contracts. the company was reimbursed for all direct and indirectcosts, and received 3-5% of total revenue (base fees) and a portion of theoperatin profits (incentive f&s) above a specitieJ Imel. fin an October 1992presentation to security analysts, Marriotts chieflinancia! oflicer indicatal thatbase kes were expected to contribute approximately 74% of 1992 operatingincome from hotel management operations.) T~K low volatility of the cash flowsfrom the management contracts enabled the firm to maintain d higher kve l ofdebt relative to cash flows than would have been possible had the firm owned


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248 R. PamnolJoum al o/ i?nanc ia l Economics 43 (1997) 241-274

the hotels it managed. Marriott acknowledged the relation between the stabili tyof its cash flows and its debt capacity in its annual reports. For instance, the1991 annual report states that the companys debt capacity is determined by theamount and variabil ity of its cash flows (p. 3 1). The combination of low capitalrequirements and high debt capacity enabled the Marriott family to retaincontrol of the firm even as Marriotts revenue increased 5 12% between 1980 and1992.

Marriotts operating profits increased each year from 1986 to 1989 in both thelodging management and contract services groups. Beginning in 1990, however,the U.S. recession ended this record of steady growth. The rate ofgrowth in thedemand for domestic hotel rooms plunged from WIOO rooms per year in 1989to onIy 2,000 rooms per year in 1991. driving down occupancy rates and hotelprofits as growth in the supply of new hotel rooms continued at higher kvels.*Profits in the contract serv ices group also dropped after 1989 as demandweakened.The recession occurrt.4 at a particularly crucial time for Marriott. As shownin Tabtz 3. the firm? inventory of h :A properties being devrloped for sak wasti~ AI air-time mgn. Sinu: this mventorv was tinanced largely with debt, Marriottwas highly levered and required substantial cash for interest payluents A $134million decline (from $509 to f375 million) in cash flow from operations reducedthe company% cash flow coverage ratio (the ratio of cash flow from operationsto interest expense) from 2.75 in 1989 to 2.05 in 1990. This weakening financialposition prompted Moodys to downgrade Marriott s debt in 1990 and again in1991.

Marriott could have used proceeds from hotel sales to reduce debt. However,hotel values in the U.S. dropped 18% between I989 and 1991, making it difficultfor the company to sel l hotels for prices that it considered acceptable. Theimpact of the weak hotel market on Marriotts financial position after 1990 canbe seen in Table 3. From 1986 to 1989. Marriott invested an average of f77Smillion each year in new hotel development and sold ownership interests ofroughly the same value. However, hotel sales declined dramatically after 1989.Proceeds from hotel safes dropped from $900 million in 1989 to $600 million in1990 and to only $33 million in 1991. Even though capital expenditures fell to

%IC supfdy and &m ad tigwu arc lrom Sm ith Travel Rexarch (STR) of Gallat in. Tcnncssa. STRatimatcs the cbustk supply d hote l rooms from pubhkd hote l directoks and dem and fraaOpCrh.I6 data provikd by hod operators IO 1993, the STR dat&asc induckd inform &on on31.ooO lodg iqf popmics Operating data xuch a.5 occupancy and avcrags room rates were mportcdby operators of approximatdy 17.CNlO of tbcsc popcrtk in 1993.The 18Y0 QIIIZ ix computal from the hotd valuatmn index report4 by Hospitality Valuation!kvicc~(HVS)dMincda.fUcw York.Theindca~antir~sseparate HVS bote l valucindexcxfor23major US cities The city indexes are dcvdopcd using data provided by STR and HVS cxtimatcs dlocal anls a nd fequi nd investor feturnk


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R. Pam~ no!Jovmal y/ i?nanciai Economics 43 (1997) 241 274 24 9

Table 3Marriott Corporatton hatonca l balance sheets. hote l property sales develop ment expenditures, andsenior debt ratings._ -... ..-_ -. . .-. - . . . -- _-.-

1986 19lt7 1988 1989 1990 1991 1992-.- --____-_-----..--_-_-_-__Cwt.so/ i&ted b~bncv .s/uvt.s us fff hau l !-ear end (5 mtllionsrAsms

currcn1 asuts ml 919 9%Properly and equipment 2207 2w578 2575Assets held kr sak:

Hotels dcvulqcd k r sak 2 213 475other 384 288 571

olkrasscls I.158 I .372 I .370Total assets 4Jn)Gii 5.97:!

Liabilitks and sharehokkrs~ equityCurrent liabdiltes I.018 I.123 I.292L4mg-tcrm debt 1,663 2499 2.857Convcrtibk subordinated J&t

(LYWQOther long-temt liabdtlks 908 938 I.122Conw ttibte prcfcrmd stwkCom m stock and retatncd

earnings 991 811 701

I.173 I.428 1.023 1.4%2.298 2.174 2485 3.461

92 757 7

1.7076.732

I.416 I.637 I.335 1.4%3.286 3.S% 2979 2 .732

I.402

62 X 407 479 snc

90 0

89 0

I.062 I .?o?212 21

I.450 1.368 I.4536.926 GiiL410

210 22KlJt4 I.197 I.169

,x0 200

Qo 32 346733 199 46

Mood y5 rating for scmor note5 onDooanbcr 31 A3 A3 A3

l Estimated from documents tikd by Mamott urth the SEC.A3 Bad Baa3 ad

reflect changing economic conditions in the industry. the book value of hotelsheJd for sale increased from what was already an all-time high of5927 million in1989 to S1.303 million in 1991.In an etrort to strengthen its weakening financial position. Marriott replacedsome of its senior debt with subordinated debt and convertible preferred stockissues in 1991. The subordinated debt. which consists 4 convertible zero couponnotes (LYONS), reduced the amount of cash required for interest payments byapproximately $18 million per year or 6.8% of the S265 million total interestexpense in 1991. Both the LYON and preferred issues lcwered the riskiness ofMarriott% remaining senior notes and debentures by reducing interest obliga-tions and the total amount of senior debt outstanding.


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25 0 R. ParrinolJownal of Financial Economics 43 (1997) 241-274

At the beginning of 1992, Marriotts ability to finance new investments withlow-cost debt was limited by its Baa3 bond rating. Furthermore, an equityfinancing would have diluted the Marriott familys ownership. This financialinflexibility prompted the firm to search for a means of removing the unsoldhotels and the associated debt from its balance sheet. On October 5, 1992,Marriott announced its spinoff plan.

4.1. The announcemenrUnder the spinoff plan announced in October 1992 the lodging management,

food service and facili ties management. senior living services, and distributionbusinesses were to be spun off into a new entity called Marriott International(International). The parent, to be renamed Host Marriott (Host), would retainownership of the hotel and senior living service properties other real estate;Tt:k ;:. Ald fi,, khb. - f-,-.dkl Play busins International would manage thehotel properties under long-term contracts similar to those with unalISatedowners. Marriott family members would continue to oversee all of the busi-nesses and the senior mana@rs would be split between the two post-spinoffcompanies. The Appendix provides a detaikzd chronolw of events surroundingthe spinofr.Marriott ofk ials argued that the separation of the management businessesfrom the rest of the firm would create value in several ways. First. it would allowthe company to mote fully exploit growth opportunities in the managementbusinesses J.W. Marriott, Jr, the firms chairman, stated that International.with its strong earnings, stable cash Bow. and improved investment capacitywould have greater growth potential after the restructuring because of itsimproved financial strength. Second, the company proposed that better finan-cial information after the spinoff would enable the capital markets to moreaccurately assess the true value of the firm. Finally, Marriott executives main-tained that the spinoff would be&t shareholders by providing them withimproved in vestment alternatives J.W. Marriott, Jr. stated that it would giveinvestors a clear choioe betwan a management company positioned for growthand a capital-intensive company with strong cash flow and long-term appreci-ation.Panel A of Tabk 4 presents pro forma balance sheet and income statementfigures for Host and International that were released by Marriott after thespinoliannouncement Virtually all of the long-term debt would remain at Host.Internationals exposure to long-term creditors would be limited to a Saoomillion line of credit that it would extend to Host. Marriott managers indicatedthat pro forma I992 interest coverage at Host, excluding capital expenditure


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R. Pam no/Jown al of &anciat Economics 43 (IVY?) 241-274 251

and working capital requirements, was expected to be only 1.6 times theprojected annual interest expense of S225 million. Based on actual 1991 cashflows, pro forma interest coverage at Host was half of that at Marriott (1.3versus 2.6).The stock market response to the announcement was consistent with thebenefits proposed by the company. The price of Marriotts common stockincreased 11.68% during the three days following the announcement (from$17.125 on October 2. 1992 to S19.125 on October 7). The value of both theStandard and Poors composite index and the hotel index declined during thisperiod. resulting in market- and industry-adjusted returns of 13.79% (S236.3million) and 13& % ($224.9 million). respectively. These returns are significantat the 1% level.Whik Mamott managers did not publicly acknowledge the possibility that

some of the shareholder gain had been realized at the expense of the bond-holders. it quickly became apparent that the spinoff was expected to redua thevalue of bondholder claims. Moodys lowered its rating of Marriotts senior debt

Tab& 4Pro loma bdamx sbaa ad ir- statamnl data lof Marmot Intcmatwnal and tirm Mamottudcr lbc oligina l bpinoll phi Iaaf was a- inOcloturI992araithelinalpheaq*adbymajnr boadbolder groups in M8rrh I993 and unplanentcd tn October l994? all numhm cnucpl lhcratios d EBI TDA IO intcre+l cxpc. u arc tn mifbon s d dollars..__- -Pad A: original lpimgplm

MarriottCorp~ratioll

MarriottIntcmaricmalpro-

Ii054 Mar-riot1pro hlm.a

hellCurt assetsProperty and quipmcntorbcr awesTotal assc~s

Liabditics and cqwtyCumnl liabilitiesLong-~ d&lOther long-term liabilities?%areboldcrs equity

Immne starmaem~ I I I 92Bb

I.230 I.120 303.672 .Mo 3.3101.431 870 I.060

h.33? xiii Tzii

I.189 1.l.W ?I02.891 20 1870I.500 690 I.310

753 520 230

RCWXllU 8.331 7.426 I.656Opcnting profit 478 314 I48Netinwme 82 145 WJIEBITDNint rnxt rxpcnsc 2.6 20.3 I.3___.--- - -_.. - . . . . ._._ ... ..-.. -- . ---.-


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25 2 R. Pam~ no/Jowna l of Financid Economics 43 (1997) 241- 274

Table 4 (continued) __._ . -__--. --.---._-.-.Pane l B: Final spinoflplan

. ._ __ _- - _.__. - ..-Bala nw .shrrr f1/1/93)L

MarriottCorporationMarriottlntemationaipro forma

AnutsCurrcnl assetaProperty and equipmentohraswtsTotal assets

Li8bihties and equitycurrco1 IiaMtklmlpkrm debtotkr loag-tmn liabititishr- spicy

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from Baa3 to Bat on the day of the ann ouament and. two days later, pressreports indicated that prices of some Marriott long-term debt issues haddeciined by as much as 30%.The dealer bid price data reveal that the prices of ail of Marriotts fixed-income =uritics declined during the three days following the spinofl an-nouncement. The aggregate market-adjusted value of the 13 senior notes anddebentures f&l1 16.51% ($333.3 million). In addition, daily closing prices fromThe Wall Srreer Jound reveal that the aggregate values of the LYON andprcknzd stock issues also declined during this period by 7.09% ($16-0 million)and 3.59% (S9.0 million), reqectively. The 3358.3 million decline in the value ofthe debt and prderred stock -ted 14.35% of their combined value.

The decline in the aggregate value of Marriotts fixed-income securit iesindicates that there was a wealth transtcr to the shareholders. Furthermore, the


13/34

R. Panitto/Jounwl oJ Financial Economies 43 (I W?) 24i- 274 253

fact that the magnitude of the bondholder and preferred shareholder lossexceeds the common shareholder gain suggests that all of the shareholder gainresulted from a wealth transfer and that the spinolI was expected to destroyvaIte4 No evidence of wealth transfm around spinoffs has been reported inother studies Schipper and Smith (19%3) find that prices decline for only I 1 of 26bonds arouod spinoff annou ocemeots whik Hite ami Owers (1983) report thatrisk-adjusted bond returns around spinoII annou ncements are not signilkantlydiffc!fuIt from zero.The low pro forma coverage ratio at Host was one reason that the value ofMarriotts notes a~ul debentures de&red folIowing the announcement. How-ever, the e&ct of the proposed transaction on the average variability of Host-scash IIows also contributed to this &dine. The spit&f would increase theaverage riskiness of the cash flows undetlying boddder daims by distributingthe B with the most stabk cash flows to International. An example ofthis can be seen in the proposed allocation of the cash flows from the unsoldhoteI properties between International and Host. Under the manawt con-tracts between he two post-spinoII finm, International would tive a largeportion of its cash flows through meaue-based base I&s whik Host wouldreceive only a share of the more vcrhtik operating profits. A presentation byMarriott executives shortly after the spiooIf announcmka t indicated that over50% of Hosts post-spinoIIc& flows would be provirkd by the volat ik hoteloperating pro&~ To the exten that the payoff for bondholders is similar to thatforthewriterdaputoption.af~adbySmith(1979),aninxcasinthtvariability of tbe assets underlying bondhokkr daims reduces their vahre.A review of the indenture a-t for tbe Marriott senior notes anddebentures teveak that it contained 10 provisions that would prohibit tbe typeof distribution that Marriott proposed. This raises the question of wbetber thebondbohlers were compensated, ex ante, for the possibility of opportunisticbehavior on tbe part of Marriott Compring the ykk ls on Marriott debt withthe BBB3 Bloomberg indexes reveals that tbe Marriott bond yields were in facthigher than those for other debt with simi lar ratings. Tbe yields on Marriott

Whik thr musud &din e in cht value d tk hrahxmmc sccuritics cxeds Ibe inaus e io thevalue of th minm on stock fol low ing tbc spinoff an- mtit isddKcdltosaypecibdybowlars this difTcmm ir An industry analyst inform ed the authr tha1 tbac were kty W tmksinvolving Marriott bonds immcdiatdy hIlowing the spinotT anwunamen I . He nuiaclhrd thatext(lcM umczrtunty cawed 8 lack Cc l iquidity. which. in turn. i rmMd the numbe r of t rades I f ibis Istru. dealers h ad ks incOruut io0 available to lhan w bm they vet their prim Carscqucatly. th e~oCtbcbidpicawupcubrblylowrd~Ibopaiadthrnei~beCorctbc~lneatorPCWmO~in~aabwItht~~avaiLMc!o~~aput idpmrr.Thcanalysts comments aho suggest that i t is unl ikely that ding pesw~rc by institutions that ycrchudtosdlbl ldsaftcrt ludcbt wasdlnmgdd by Moodys contributed to the sharp doclinc inIbcpYicesof lhclKttcsanddebcntu~


14/34

254 R. Pam ~no/Jou mal of Financial Economics 43 (1997) 241-274

notes with two-, five-, and ten-year maturities were 37,80, and 56 basis pointshigher, respect ively, than the yields on BBB3 debt of corresponding maturities inearly 1992. These yield differentials are consistent with the expectation thatpremiums would be required to compensate investors for the lack of protectionagainst such opportunistic distributions to shareholders. However, they couldalso reflect compensation for higher risks associated with other aspects of thebondholder claims.If Marriotts bondholders did require yield premiums to compensate for thepossibility of a spinoff. then at least part of the decline in bondholder wealthfolowing the spinolTannoutuzmen t is not a wealth transfer in the strictest sense.Only the difl&nce between the decline in bondholder wealth and the value ofthe premiums that bondholders received before the announcemen tdaterepre-sents a net ex post wealth transfer to shareholders The remainder representsa recapture by shareholders of wealth that had been distributed to bondholdersthrough the premiums.

The bondholder reaction to the spinoff plan was both swift and unambiguousWithin ten days of the announcemen L, two das+acGon suits were filed againstMarriott and several large bondholders had formed a committee to expIoreways of Mocking the spinoIL By the end of December, a total of ten class-ircrionsuitsaadoDcsuitbyalgoupol~boad~hsdbeeafikdtoMocirtbcspit~ofLlhecontroversy Prompted Merrill Lynch which had been both a princi-pal underwriter for some of Marriotts senior debt issues and art advisor toMarriott on the spittolL to witMraw as ao advisor. By Iate December, Marriottagreed to hold d&us& ns with repmentatives of the major bondholder groupsopposing the distribution. The pressure on Marriott to modify its phn was sosevere that the firm agreed to pay the f&s of the advisors to the bondholdergroups to bring the bondhokIers to the bargaining table.

An agreement was reached between Marriott, the class-action plaintiffs, andseveral large bondholders in early March 1993. although the group bf laq~ebondbol&m that had filed suit in the cal l of I992 did not lind the revisionsacceptable and decided to continue its legal action. Major modifications to theinitial spinolI plan includedzI) the transfer of $400 million in additional assets and debt to International;2) an agreement through which International would provide $125 million infinancing for the unfinished Philadelphia Marriott hotel;3) an increase in the line of credit provided to Host by International from S&N)to $630 million;4) the retirement or defeasance of all of the debt maturing before February 19w(thre issues with a face value of S350 million);


15/34

R. Pamm~J ownal of Financial Economics 43 (1997) 241-274 25 55) the exchange of all remaining notes and debentures (ten issues with a facevalue of S1,520 million) for new Host debt with stricter covenants;6) an agreement that Host would use up to 75% of the net proceeds fromcertain asset sales to repurchase debt issued under tbe exchange agreement.The coupon payments on the debt issued under the exchange agreement wouldbe loo basis points higher than the corresponding rata on the old notes and thematurities would be extended by four years for nine issues and reduced by fiveyears fbr one. As part of the exchange agctmcat, $174 million of tbe $1,520miUion of exchanged debt would also be retired with $70 million of Marriottstock and $104 million in cash In addition to the spinoff plan moditicationrMarriott agreed to pay $1 million to the das+act&n plaintiffs for lea andexpenses and to issue 7.7 milhon five-year warrants to purchase Host stock tobondbokiers who sold their claims at a loss following the October 1992 an-nouncement~financlalimpactoTthcmodificdspi~planibapplrtntinpandBolTaMc 4. The ratio of book debt to total capital at Host would be lower thanunder the initia l plan (0.89 versus 0.95) and the interest coverage ratio. based onthe pro forma msuhs from the previous year, would be hi&r (1.8 versus 1.3)Furthermore. the mised capital structure and the extension oft& maturities formost of the notes reduced tbe immediate threat oCa Host ddauh ;Oy oweringdebt service and principa l tepayments during the first few years Mowing theqinoli.

The revised spinoff plan was approved by the Marriott sharebokkrs oo July23.1993 aud the distribution was completed on October 8 in - withthe revised plan. AU but two bondholder groups. the grwp that fikd suit in thefall of 192 and the Florida state pen&n fund which filed suit in late March1993 to block the revised plan, settled their claims by Lhc distribution date. Thesuit by the Florida pension fund was ultimately settled in April 1994 and the lall1992 suit was dism&al in January 1995. The agreement with the Floridapension fund required Marriott to purchase the $7.6 million in bonds owned bythe fund at face value.4.3. Skcmrity rehms hetuven anno6weme nt and diswifwiott4.3.1. Cwnnum smck

Table 5 reports common stock returns during the period between July IO.1992 and January 4, 1994. Returns are teported for three-day event windowsaround key events, except that a six-day window is used for the bondholderagreement anno uncement hecause two Wall Smef lmfmtd artida pubhsbedthree days apart, reveal nonoverlapping information about that agmement.Cumulative returns are also reported for the period from the announcement onOctober 5, 1992 through the distribution on October 8. 1993.


16/34

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18/34

258 R. Pam no! Journal o/Financial Economics 43 (I 997) 241-274

The market- and industry-adjusted returns arc only significant around thespinoff announcement and the Merrill Lynch resignation. The negative reactionto the Merr ill Lynch resignation indicates that the market interpreted this eventas a signal that shareholder gains from the distribution would be smaller thanpreviously expected and/or that the distribution was less like ly to take place.Merrills etTort to distance itself from the spinoff may have been interpreted asa signal that bondholder opposition to the spinofT plan was stronger thanexpected and/or that legal chalknges to the plan were like ly to succeed.While none of the adjusted returns around other events in Table 5 ansignificant, the -4.24% industry-adjusted return for the bondholder nego:i-ation annou ncement suggests that these negotiations were expezted to reduceshareholder gains. In fact, the -4.24% value does not reflect the entire pr icedecline associated with this event. During the five trading days leading up to theDecember 29. 1992 anaou ncement, the industry-adjusted return was -6.69%(r-statistic of 1.80). suggesting thar information concerning the negotiationsbegan lo be reflected iv prices ar earl; as December 22.Fig. 1 illustrates cumulative re: ms on Marriotts cornwon stock for the+iioU ctiver& AI, 1a1~ 3. the industry-adjusted plot shows that the positivereturn following the announcemen t was largely offset by the negative returnsaround the Merrill Lynch resignation and the bondho&r negotiations an-nouncement. Marriotts stock returns were similar to those of the industry fromJanuary 1993 through the distribution in October, except for one increasearound an eariy-January positive earnings announcement.The stock returns during the period from announcement through distributionprovide lit tle evidence that the spin& increased shareholder value. Whik theunadjusted tetum on Marriotts common stock during this period was 93.93%.much of this return is explained by changes in the industry index. Tbe industry-adjusted cumulative rptum is a statistically insignificant 4.84%.s Tbe industry-adjusted change in the value of Marriotts common equity from ~beannouncement through the distribution was only 580.6 million. computed bymultiplying each daily return by the dividend-adjusted dollar value of thecompanys equity at the end of the previous day and tben summing these dailyvalue changes.iI is possible that the sharcholder gain cxcccded SO.6 million but rhatpoor performance relative to other industry firms offset much of the increase.

The period beman the an nounamm t and distribution coinckkd with a strong raxwcry in thehod industry fdiow ing the 1990 -91 ramsionTlwraurasto shrrcholdmalaUOC thefinnsin~hod index cxacdcd the 1114% mum on I& S&P 500 index during &is period. Tbc total returnsbchvccnthea ~~wmccmc~t and distribution for the individual hold firms are 38.39% br La QuintaMotor Inns L.P.. 136.46% for La Quinta Motor Inm Inc. 127.68% lor ShoLod~ Inc.. 143.33% forHospitality Franchise Systems. Inc. 55.79% for Marcus Cor pomtio n and 36.76% for Red Lioninns L.P.


19/34

R. PamnolJ oumal of Financial El wwntics 43 II V97) 241. -274 259


20/34

260 R. Pom no/Jown al of Financial Economics 43 (1997) 241.-274

However. the evidence is not consistent with this explanation. Press reportsbetween the announcement and the distribution reveal no evidence of poorrelative performance at Marriott. Furthermore, the industry-adjusted plot inFig. 1 is inconsistent with poor relative petformance between January andmid-October 1993. This curve would most likely have been downward-slopinghad the market received signals of poor petformance during that period.Instead. it is flat.4.3.2. Fmjid stockThe unadjusted cumulative return for Marriotts convertibte preferred stockand its daily trading volume are illustrated in Fig. 2.a. The negative 3.59% returnfollowing the spinoff announcement indicates that preierred shareholders ini-tial ly expected the spinolf to reduce the value oi their claims However, this losswas more than offset by gains during the following month as the unadjustedvalue of Marriotts co~mott eqr!ity increased beyond i ts post-announcementlevel.XL p.cterre;i sturare~,me couvertible only into shares of Host stock afterthe distribution. Therefort, the change in the value of these securit ies betweenthe annou ntzment and distribution dates was agected by the adjustment of theconversion ratio from shares of Marriott stock into shams d Host stock.Apparently. most @erred shareholders believed that this adjustment wouldnot favor them because approximately 92% of prdemd shares outstandingwere cortvcrtcd into Marriott common stock before the adjustment was an-nounced. This was a costly error for those who converted because Marriottoverestimated the value dtbe distributed shares when it set the new conversionratio. The ratio was adjusted from 2874 shares of Marriott common to 19.160shares 0; Host common based on the assumption that the distributed sharesrepresented 85% of the value of Marriotts equity. The actual percentage, basedon the initia l trading prices Ot the Host and International shares, was 79%.Consequently, p&&red shareholders who did not convert their hotdings priorto the conversion ratio adjustment realized a pm-tax windfall gain of 40% onthe day that the new ratio was annotmced.6 This gain, which is a wealth tran&rfrom the common sharchokkrs, is illustrated in Fig 2a by the sharp increase inthe cumulative return on October I, 1993.Fig. 2b shows that the p&rred share price premium over its conversionvalue dropped sharply after the spinoff announcement from approximately 514


21/34

R. PamnolJoumaI of hanc iat Economics 43 (1997) 241 274 261

Fig 2b. Marriot t p&nuJ rtoc& price io exas d its amtwx ion value from Julj IO. 1992 rhr,.,ghJaonuuy 4. WM.

to $5, where it remained through the end of 1992 in 1993, the premium-to-conversion value gradually declined to a level of approrimately $3 at the end ofJune and then dropped to are during the T.ra week of July. The July dropMowed the denial by a Deiawar c court of a request from a p&&red share-holder group to postpone the meeting at which the common shareholders werescheduled to vote on the spinoff.4.3.3. L YONsThe Chkugo Trihw reported on October 27.1992 that the language in theLYON indenture was u&r with respect to how those claims would bea&ted by the spinoff and that the Marriott board had not yet decided how totreat those obligations. Uncertainty concemmg how the LYON claims would be


22/34

262 R. Pom ~no.lJou mal of f inancial Economics 43 11997) 24/- 274

Fig. 3a. Marriot t l iquid yield opt ion IWIC cumulat lvc wadjustcd returns an d trading volume IramJuly IO, 1992 through January 4 1994.

b-~g. 3b. Marriot t l iquid yidd optLo note pncc In caocu; ul~ts u~wsion value frum July IO. I992through January 4. I994

treated in the spinoff appears to have contributed to the 7.09% decline in theaggregate market value of those securit ies during the three days following theannouncement (Fig. 3a). After the initia l decline, however. the cumulativeLYON return exhibits a pattern simila r to that of the preferred share price,gradually increa&ng with the unadjusted common stock price. The LYON pricein excess of the conversion value also dropped sharp!y at the time of theannouncement and then gradually declined to zero (Fig. 3b).Unlike the p&erred shares, the value dthe 1 YON claims was altered little bythe spinofi. Tbe LYONS became an obligation of both Host (IO%) and Intema-tional(90%) and remained convertible into an equal number of shares of eachcompany. Tbe lo/90 split is consistent with early estimates d the relative valuesof the two post-spinoff companies. suggesting that an effort was made to


23/34

R. Paw iiwihm d of Financial h-momics 43 (1997) 241-274 263

structure the LYON claims so that they retained proportionate rights to thecash flows after the distribution.4.3.4. Notes and dehentures

Fig. 4 illustrates the cumulative unadjusted and market-adjusted returns onMarriotls senior notes and debentures. The cumulative market- and industry-adjusted common stock returns are also presented for comparison. The initia ldecline in the aggregate value of the notes and debentures was followed bymodest increases ir. mid-October 1992 and between mid-December and mid-January. lhesc incteases correspond to events that ate like ly to have beeninterpre:ed as r~&cing the expected bondholder loss from the spinoff. TbeOctober increase coincided with the filing of the class-action suits and theformation of the bondholder committee directed at Mocking the initia l spinoffplan. The increase at the end of 1992 occurred around the initiation of thenegotiations between Marriott and the bondholderslhe wealth loss ultrrllately incurred by holders of the senior notes anddebentures was less than the 5333 t million decline that followed the spinoffannouncement. By the end of January. the market-adjusted value of the notesand detzntures was only SI 51.0 million below their value on tbe day hefore thespinoH annou ncement. The aggregate senior bondholder loss remained atroughly this level through A.*gust and then increased gradually to 5194.6million (9.98%) on the distribution date.

The dif5zretu.z between the 5194.6 mGon market-adjusted bondholder lossand the 580.6 million industry-adjustea shareholder gain suggests that thespinogcaused a $I 14.0 million decline in the total value of these securit ies Thewealth transfer to preferred shanholders that resulted from the error in theconversion ratio adjustment accounts for approximately $12 5 million of thisdecline. If the LYON claims were unatTected by the spinotT. the di&rencebetween the S114.0 million and S12.5 million figctres indicates that tbecost ofthespinofi was expected to exceed the value it created by S131.5 million. Thissection considers why the value or Marriotts secur ities declined.

Tbm were 326..3 66 prckmzd shares outsta nding when the con-on ratio was adjusted . IfMarriott had cortrctly cstimakd the value of the disttihu tion. the convcvion ratio would have been13.666n1hcrthan 19.160. ThcSI2.5milkn Egurris theproducl ufthcdilicrenabctw&n these tworatios the 57.000 price at which the Host shares be pn trading and the number of pcrcmed sharesoutstanding.


24/34

R. Pawin oiJoum d of Finmcial Economics 43 i!H7) 241 27 4

I

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25/34

R. Pom nofJou mal oJ Financial Economics 43 (1997) 241- 274 26 5

5. I. Sources of t;alueComments by Marriott officials as well as arguments in the literature suggestseveral ways in which the spinoff could have been expected to increase firm

value. As .I. W. Marriott, Jr., suggested, the spinoff might enable tbe company tomore fully exploit value-creating growth opportunities in tbe managementbusinesses by reducing capital constraints. However, it is not clear how largethis benefit would be. The capital constraints were largely &f-imposed sinceMarriott could bcve financed attractive investments through equity s&s whenite %tancial position deteriorated It is also worth noting tbat Marriott was ableto s:ll $400 million in lO- and 20-year debentures at 9.50% and lO.OO%,respectively, during April 1992. Tbe magnitude of tbe value reabxed fromimproved access to debt capital depends on the extent to which tbe Marriottfamily was willing :o turn down valuable investments in order to avoid equitySaks.As Marriott of?icia is also suggested. tbe spinoff might enable the capitalmarkets to more accurately assess the true value of tbe firm by improving tbequality of financial infombation available to investors. However, a spinofi is notnecessarily tbe least cost ly way to provide the markets witb such infotmrtion.nor wil l tbe benefits from the avai lability of better information -ri lyoutweigh tbe costs of pro& ii 9 it. The incremen talcostofmaintainingasecondsetoffinancia I records and maiaging a separate stock is5ue can be substantial.In addition, tbe diiure of more detailed information concerning Marriottsbusinesses might beip its competrtors.

Fig 4. Cumulatiw returns on Marriott senior ocbt and qutty bewun July 10.1992 a nd Januaty 4.WM.Tbcunadj~sfflior~rcturosarr~~drom~priotriortbci3prMidycrd+dpawsdnotes and ckbcnlurtx 0uIstan diq on hc dale dthc spinolfa nncunm .mt (oT,cbtr 5. I992 l. Bad~llnrs~Qctobcr8,1993rrtlcdchm~inthr\~ucoTquityrmivcd~ancrcslngc!k The nurkc:-adjusted senior tkbl tclwm am ahha l from dunp m rhc ydds 04 2-. 5-. adIO-)ru8B83bondindicesnporttdbyBbom~wairrcuNrrrSmiEccmrtLcwnplt~TbevIh*oCadraocc~~urrIcriaLiadividur~vldjugodunn8lht~~isdcxthcmm 4 dmdy rnatdwx its matunty. The market-adjustfd coamwn stcdimumsqua llbccom-prmdal daily p~~Ji&on erron from a market model The&y prcdikm erron fmm July IO. I992throu#h the tradh day paccd& the spina(l lnnounaCme n t @rmbcr Z 1992) arc obtained uxingtk pramctcrs from a market & estima ted over the 200 tr,.hng days endin g 61 trading daysbdorcthcan llouncX mcnt Daily prsdiclioa cmns hm the Jllmnmcc ma 1 day foctobcr J. 1992)through January 4.1994 YE obtained ting pammetax hnnamixrkctmoddttuci5cstianatiovcrtb 200 trading days bCgiIlllifl~ i ~twlhg days d&r the distribut ion on Cktobcr 8 1993. The sdr P500 index is used to estima te the market mode ls The indwtry-a&ted rrturnx CqupI tbc corn-pcmdd dilfcmna bctwcm the daily mum 00 Marriotts common stoc+ and the daily return on anquai-w eighte d index amstructsd usi08 ruumx kw six hote l lirw. The timlx used to amstmct thehctd index include H ospitality Franchise Systems (aticr &am ber IO. l99Zk Ins.. La Quinta MotorInns Inc., La Quinta Motor Inns L.P.. Marcux Corporation. Ral Lion inns 1 P., and Sholodgc Inc.


26/34

266 R. Pam ~no/Jou mal of Financial Economics 43 (1997) 241- 274

The Marriott argument that the spinoff would benefit shareholders byproviding them with improved investment opportunities is consistent withHakanssons (1982) conclusion that a spinoff can increase the set of investmentsavailable to investors in an incomplete market. However, this benefit is unlikelyto be large, as a wide variety of real estate investment trusts and hotel firms werealready publicly traded in 1992.

To the extent that accounting and market performance measures wouldbetter refect managerial performance in the post-spinoff companies+ as sugges-ted by Aron (1991), the spinoff might also enabk Marriott to write more efbckntcontracts with managers owning modest equity stakes. However, the potentialgain from improved contracts with managers is like ly to be limited by the activeparticipation of the Marriott family in the management of the company. Thefamily has strong incentives to closely monitor senior managers and access toproprietary information that would be useful in evaluating their performanceThe spinotT is alio uuhkely (0 substantially increase tbe value of tk firm:hr oug!, .4xr m&s Ii


27/34

R. Porrim/Jow aaI ofhancia~ Economics 4J (1997) 241-274

Tabk 6Cat8 dtk Marriott spittoP

267

!soora COSt-. ---- ___ ___ ---_.-_---. .---.-.-----..--^_cOustharMbequulbtkdDimctdm~taqnizdiafttuthJstatcttunts S23.4

LooO((brability(oodidHo4bPawilbMlrrio(tlntanrtioarlpoh~ S3.1Akr-t8xlo88fraoboad~ S5.0V8htcdw8tTaot8i88dulMkl-~t s29.3Total Gii i i

otkrco8ts . .Dt+amod8aYoootiog8od~8y8tao8 INHigkrsawity inamaacortr Id

and a S19 million pretax Ios in 1994. If the spinoff had not been compktai,these cartyfotwards and losses could have o&et profits from tbc vtbusincosff Assuming that Host is unabk to use tbe associated tax shields for~)~aadusinsamarsi~tarratcof40%andadisoouotratcdl~~,thepnscatvalutoftbecostoldeCerriogthtuscdthcsetaxshiddsisS3.1million. Additional losses at Host ord&rraJ of the use of the tax shidds formore than three yeas will add to this cost.


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268 R. Paw innlJou mal of Financial Economics 43 lIW7) 241. ?i4

Marriotts tax payments could also be accelerated for another reason. Byisolating the hotel properties from most of the firms cash flows, Marriott is nolonger able to immediately use tax shields arising from the sale of hotelproperties for less than their book values. With many hotel property values sti llbelow their 1989 kvels , there was a real possibil ity of such sales at the time dtbedistribution.The March 1993 bondholder agreement also proved very costly . In additionto the $1 million cash settkment with the class-action plaintiffs (&kc&d in thespinoff-related charges discussed above), Host recognized a $5 million after-taxloss on the exchange of the notes and debentures. Furthermore, the 7.7 mil lionwarrants that Marriott agreed to distribute to former bondholders were alreadyin the money when they were distributed. The value of these warrants, estimatedusing a binomial option pricing model. was $29.3 million on the day that theo&ring prospectus was filed.The spinoff could ako result in o?erating i&i i&&s and incmased coststF: I ala: zn1 tail, AUdf. I!% ujmg guMic info,mation. For instance, the dupli-cation dadministrative f&as at Hart and International could increase totaloperating costs. Each firm maintains separate accounting and finance stafis. aswell as systems ror lmnqing &uebokkr rdations and tracking share owner-ship. Fur&rmom, as rudegted by Hite and Owers (1983), the spinofl couldlimit ecoom&s d sak in future eii0rt.s to raise capital.

Finally. the rpinoIT is like ly to mise the cost d future debt issues and/or forceMarriott to accept more restr ictive covenants. The etkct of the spinotTon thecost d future debt issues was mentioned frequently in press reports following tbeannounameot. Comments attributed to financial profeAo!rak indicated thatthe spinog would make it more difbcult for Marriott to raise capital because itwould cause investors to revise their estimates of the likelihuod that Marriottwould behave opportunistically in the future.ICmarkacstimatcsdtbecosts associated with the spin& were simi lar tothose reported in Tabk 6, the diRerena between the 360.8 mil lion in quantifi-l bk costs and the $101.5 net securityholder loss suggests a lower bound ofS40.7million for the expected cost of ir&c ien& and higher debt issuance costs~tingfromtbtspinoll:Thir~.fmilliondiRrrtaocw~equabI.l%o(tbemarket vahre dtbe Marriott-s public securities on the distribution date, is a lowerbound because it is net of any value that was created by the restructuring.

If the shareholder gain following the announcement was largely o&t by pricedeclines in November and December 1992, and the stock price performance in1993 was no different than it would have been haJ the spin& not beenproposed, the question arises as to why Marriott completed the distribution.


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R. Pam no/Jown al of Financial Economics 43 (1997) 241-274 26 9

One explanation is that the Marriott family feared that backing down in tbe faceof strong bondholder opposition might harm its reputation and the reputationsof other senior managers. As long as the public shareholders were not harmed,the family may have seen no reason to alter i ts plans. While this explanation isplausible, the Marriott family could have expected to beadit from the spinotT inother waysFirst, the spinoff reduced the likelihood that the family would lose control oftbe entire firm. The deterioration of Marriotts financial condition had left it ina precarious position and prospects for improved performance were uncertain.Continned poor performance might have pushed the firm into financial distressand caused the lami ly to lose control. By legally -rating the profitablemanagement businesses from the real estate and much of the pubhc debt, thefamily was able to redtnx the likelihood of losing control.

ThespiaoAalso~tedthcpotca~losscstothcMarriottlPmilyinthetventof a default With Marriott stock comp&ngahighproportiooofitstotalnetworth, the Marriott tily is like ly to have been more conarnod than otherrvdldiversified investors &out the unsystematic risk ofits po&lio. To theextenttbPttbcCamilyval~thend~dthioristt&lamifyhadaninocntivetocompkrcthcspiooacreailitJidwta&aaIbemuirctpriadlhtfim?ssbans.Finally, the family benefited from the spiaotT because it improvod the maaage-mat businesses* access to A-51 capital By using the spinoff to separate tbemaoagcmcnt businesses from he asociata4 teal estate, tbe family was onceagain in a position to aggressively pursue growth opportunities without riskingdilution of its ownership position.

7. c-Marriott spun off its management businesses in reaction to changes ineconomic conditions that made its operating strategy meft&tive. The spinoffaccomplished what the practice of selling hotel properties had done for the 6rmia the l9tlOs. It enabled Marriott to separate its management businesses from

mucbofthe associated real estate. However. tbc e&t of the spiooff on tbe firmssecurityholders was quite difTercnt from that of hotel sales 1 Mike hotd sales,the spinoff reduced the value of the assets underlying bondholder claims. Thededine in interest coverage at Host was not accompanied by a commensurateincrease in bondholder returns.Nonetheless, this case illustrates how bondholders can inguenaz corporatepolicy even in the absence of explicit covenant protection. The bondholderswere able to force the company to modify the spinotT plan in ways thateliminated most of the initia l shareholder gain. The value created by the spinoffwas more than offset by its cost and the remaining bondholder loss was largelyconsumed by transaction costs and inefficiencies


30/34

Chronology oJer!ents in the Marriott spinofl

Ocroher 5. 1992Marriott announces the spinoff plan. Shares in the compa nys managem ent busi-nesses are to be distributed, on a pro rata b asis, to the shareholders. The new firmwill becalled Ma rriott International(Inrernurionul) and the parent will be renamedHos t Marriott (Host).Mood ys lowers its rating of the Marriott senior debt from Baa3 to Ba2 andsubordinated debt from Bal to BI. Standard and Poors places Marriott on itsCreditWatch list for possible downgrade.oclokr 9.1992Two class-action suits arc f i led on behalf of Marriott bondholdersoclokr 15.1992New s reports indicate that a bondholder steering comm ittee. consisting of repre-sentatives frcjrn 1 I !d~gc institut8onal investors. has been formed to explore alterna-: iq rnurSer of Rr*ion aimed 11 bls, cm g the proposed transac :ion.

Ub.dw ~9. iW,A third lawsuit is f i led by a group of investon coikctively hording approximatelySIZO mill ion of senior Marriott debt. The suit alleges that Marriott improperlyfailed to disc lost the restructuring plan wben it issued S400 million worth of SeriesLand!kriesMSeniorNotesinApril i!?Q.The bondholder steering com mittee is reduced IO seven mem bers with the defec-tion of three me mb ers to the group filing the suit and tbe departure danother forotber feasons

Norm&r 9.1992First Na*ional Bank d Chicago resigns as trusta for the 13 note and debentureissues that Marriott has outstanding.Normher II. 1992Bane One af6liate First Chicago Corporation is named as the new trustee for theMarriott debt.Duff and Phe!ps downgrades Marriott nom and debcnturrs from BBB to B.Liquid Yield Option Notes (LYONS) from BBB- to B-. and convertibk prefer&stock f rom BE LO CCC .Norember It. 1992%andard and Poors announc es tbat it will downgrade Ma rriotts senior un-secured &%t from BBB to B. its LYONS from BBB- IO B. and its convertiblepderred stoc k from BBB to CC C when it becom es clear that the spinoff willoccur as currently planned.Normber 17. 1992Merrill Lynch & Co. w&draw s as an advisor to Marriott on the spir& plan.Merril l. an underwriter d several Marriott debt issw s. has been crit icized for itsassociation with tbe restructuring plan.Nowder 20.1992A Federal judtqz combines the bondholder suits against Marriott and delaysinterviews with potential witnesse s until January 8 1993 so that Fe-trial paperwork can be annpkted.


31/34

R. Pamno . Journal of Financial Economics 43 (I 997) 241-2 74 271December 29. I992

Marriott announces that it has begun discussions with bondholde rs in an sfiort toaddress their concerns with the spinoff-Ten class-action suits have been tiled against Marriott by this date.

Janwwy 8, 1993Marriott and the bondholder groups suing to block the reorganizationagree to postpone the next court hearing , scheduled for January 8. unti l January28 .Jam my I f , 1993J. W. Marrioa. Jr.. announu s that Marriott had strong pro forma eami og in1992 Operatint- profits are expefzted to be between 1490 and SSOO million . 1991operating profits were S478.Jam my IL 1993Marriott provides details of its bond exchange proposal to the bondh older groupswith which it is negotiating. The proposal inch&s lcq+cniog the matunty of thebonds by four years and a sweetener consisting off50 mi llio n of Marriott comm onstock.Janwl~ 25.lW3Each of the three bo:tiho &r groups countcr~ the Marriott proposzt The rernarn-ing members d the bondholder staring committee propose keeping tbe companyas a singk entity whil e distributin g separate shares Tar each of the two segments.The group that filed suit on October 29.1992 (the suing boodbolder group) agruswith the steering commit- proposal but adds that if Marriott insixts on spinn ingoIV Inrrrmariad that tk latter should cross-guaraalcr the Host &bt. Reprrunta-Iives of the class-action plair.tilts propose an initial pub lic of&q of Irrtminnalstoctwithtk~uscdtopay&wasomedHoztsdebcMarriott rejects these propos& but o&s to change the s~ucturr d the transac-tion so that fnrrrnarionol will take land valued at 5265 rnillioo and asxume theassociated debt.Febnw y 2. 1993The suing bondh older group annd>unces that discussions have substantially-broken down. A Marriott spokesman says that disunions are contin uing withmajor bond-.

h4aJz-h 8. toy3Thr Wall Strref Journal reports that Marriott is o&rin g to alm ond tk restructur-ing proposal. Marriott says that it expects to rCMh an agreem ent with thebondholders within the next few days.Marc-h 9, lW3Marriott reaches an apreem en t in principle with the c&s-action plaintiff s.Mach IO. 1993Marriott reaches an agrecmcnt in primzip& with the bondholder steering mm-mittee.Man-h II. I993Marriott announces that the spinoff is b&g moo& A in accordance with anagreem ent betwe en Marriott. the class-action pIaim % and the steering corn-mittee.

March 2.5. iW3floridas state pension fund files suit to block the revised spinoff plan.The suing b ondhold er group sa)b that it may expand its sllit against Marriott.


32/34

272 R. Pom nolJourna l of Financial Economrcs 43 (1997) 241.-274April I. I993Tke Wall Street Journal reports that holders of Marriott s convertibk preferredstoc k have formed a group to oppose the spinoff. Thos shares, which are currentlyconvertible into 2.874 sham s of Marriott com mon , will be convertibk into onlyHos t shares after the spinotT. The conversion price will be based on the relative

values of Hos t and /n~mtati~~nal at the t ime that the latter is spun off.April 2. lW3The prckrrcd shareholder group f i les suit to block the spinoff. The suit claims thatthe reorganiwtion will result in comm on stockholders recetving dividends beforepreferred shanbo lders. Under the spinog plan holders of lntemurioaol com mo nshares are likely to receive dividends while holders of Hos t prhmd sham areunlikely to rt ive any.April. 4. 1993Tk Wail Sweer Journal reports tha t Marriott has rejected demands by thepreferred shareholder group that the spino ff plan be mo dified.April II. 1993Marriott announces that. adjusting for an accounting change. f irstquarter netincome is 513 r; ii l liou. Ihis com pares with net income of Sl 1 mill ion in the f irstqu: ierof 1992M&I . , , . , IYY.,Marriott Bks a SICK3 mill ion countersuit against the suing bondholder group. OnMa y 21. I993 Tk fhd Eqrr reports that a Marriott spokesm an described tbesuit as alkging lhat [ the suing bondhddtf group] sought to intcrfem both in ourdeals with our f ina&al advisors. . . and also that it conspi~~ I to organize a groupboyco tt O t Marriott hotels and other serv&s.hi* 9.1993The Marriott !kries H notes mature. The local fact value of Marriott s pubhc notesand debentures is nxluccd from 51.87 to Sl.77 bil l ion.May IO. 1093Marriott f iks its bond exchange oll ix with the SEC .May 25. 1993Marriott am mm wxa that the June 22 sha~cholder meeting will be res&dukd forJuly. Tbe SEC has not completed i ts mv kw of the prosy mate&Is.May 26. 1993Standard & Poors announc es that it plans to assign an A- debt fatirg to Inter-rsariotsat and that it has lowered its rating on Marriott s senior notes from BBB to B.Jw te 9. 1993A Delaware wurt dismis ses the claim by the p&erred sharrhoider group that rbespitm U constitutes a breach of f iduciary duty. Other claim s remain unresolved inthis suit.Jk+ I. loo3The Ddaw are court denies a request by the prekrred shareholder group to delaythe July 23 shareholder meeting.July 19. 1993Marriott begins the debt exchange o&u.J& 23. I993The spinoff plan is approved by 85% of the votes cast at the annual shamholderdn gMarriott announces that it has reached an agreement with the prdemd &arc-holder soup that had sued to Mo ck the reorganization. The agreement calls forthe preferred shareholders to dism iss the litigation, retease Marriott from all


33/34

R. Pam ~nolJaw d o/Financial Ecnnomics 4 3 (1997) 24/- 274 21 3

claims, and convert their shares into Marriott common stock before the distribu-tion date. In exchange. Maniott agrees to pay the plaintiffs SXtO.000.August 18, I993Marriott extends the expiration dale for the bond exchange ofkf to August 20 dueto a lower than expected response as of the previous August 17 deadline.August 24.19937% Wd/ Street lovnal reports that MatliOlt has luuila lcraJly dtangai tk swapruks, by announcing that it MI Jongcr nucds 51% of each of two bond issuu. forwhich it has faikd to ICC&C that amount in order to proceed with tk exchange

Ok.August 31.1993Marxiotl sets a new faord date of September 30 and distribution date ofOctober 8.ssTptcnltxe1.1993The Mamiolt &rim J noles mature. lk tocz face value of Marriotts public notesand dekntures IS reduced from Sl.77 to Sl.62 billion.sepmrbrr 28. 1993Tk IRS informs Marriott that tk spinotT wil l be tax-free.septtuher.9.1993Mamoll annouuccs lhat ah cond~knts necessary o proceed wxtJ i k spnoft havebcm met Tk annpanv abo seports thal. adjusting For uoncash income taxchanges and tk e!Tects&lodging dispositiom operating pro& net income. andearnings per share am up 7%. 20%. rad 15%. mspaztivdy. over lk third quarterin 1992.cklok 1.1993Marsiott anuounm that 92% 4 tk fimr adlioo convertible preened shares havebeen amvested into 10.6 million sham of Marriott common stock. Tk nmainiug

326.366 shams d prefemd stock wil l beoa&mb each k coovertibk into 19.16shares d Host stock.htemationrrl begins trading on lk Yew Yorh Stmk Exckngc wi (whm issuaitand Host begins trading both with &idend and ui (wbm issued witbout tbedivideod rights). Qandard & Po.A aunoukas lhat Intenuujollol wil l replaaMarriott in tk SBtP MO imkx aftex the dose d lrading on Octoher 8.alober8.1993Marriott issues k special divida~J. dWiveJy compiling tk spim5.fntematiold amounces au inilial quarteriy cash dividcad d SO.07per share. Thisdividend equals the quarterly dividend previously paid by Marriott.TbeSericsGnotathatmatureonFebnrar) 1,1994arcd&ascdandmnovbdfrom tk Hmr baJame sheet. Tk total hsce value d Hmrs public uotes anddebmlures is fuduczd lo SI.35 Wioa. The fl.ol billion on Szplmber 1 hat he-ureducaJbySO.1 biJlionasarcsuJtdtkdelksmm and SO.i hibiom through stockand cash payments ma& as part of tk exchange o&r.ocrober 12.1993The Host shares trade exdividend.April 28. I994Thch~tfiledbytkFkwidasca(epcnsionfundisstrled.HosragmtonPudYgcapproximately 57.6 million of oki notes held by Rorida fund at tkir par value.octo&r I,: 1994Host fiks a Prospectus for tk issu.mce of 7.7 million wan-acts lo acquire shares ofcommon stock at a price of Sg per share for three years and SIO per share duringthe following two years. Host shares close at SlO.750.


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214 R. Parrho/Joumol ojFinmcial Economics 43 (1997) 241-274

October 19. I994The trial involving the suing bondholder group ends with the jury hop&slydeadlocked. The judge declares a rcistrial. The plaintifT is seeking damages ofapproximately S18 million.Jamu ty 25. I995A U.S. Distr ict Court juds dismisses he suit filed by the suing bondholder group.The jw ruks that Marriott did not violate federal security laws in failing to~theporriMspiaoRwhrnitsoldtheScriesLandMSclliorNotuiaApri1

Aron, Ikbra J, 1991. Using I& apiur nmkd as a monitor: Corporate spind% in an agncyframework. Rand Journal of Eamoak 2f 505-518.

Cuutis, Pat&k J, Jama A . Mila. ami J. Randall Woolride. 1993. ltcstneuring tbrougb spkdkThesto&multctevideaat.JomulofFimncialE.umcmb33.293-311.

citamu& David M, 1988 spin4s and spir+Juts using suutitizatioa to beat the bu~uaacy.kxund of Applia l Cotpomte Finance I. 82 (19.

Hvh~-vn. :.:Ts j4, ;Yb, ;ha,,-; JllklitWLd~rtCl:\i&Rmdpicrcllatr~thCbuiccbsacaadvaluc eoammh, Jamal d Fi- 37.977-ltXJ4.

H&e, G&n L and Jama E

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