Case 20: Pittston

With the Initial Public Offering (IPO) market doing so well a few years ago, tracking stocks were popping up everywhere. A tracking stock is a separately traded common stock that only reflects the well being of a particular division. The parent company still completely owns and operates the division. But, the parent has its own stock price that trades independent of the tracking stock's division. Tapping into the then hot IPO market, tracking stocks, particularly those in the technology sector, were able to generate significant proceeds when offered as a separate trading opportunity. With the overall market performing so well for so long, there seemed to be no drawback to this relatively new way to raise extra capital.

The question many investors started to ask was, "What will happen if tracking stocks start to act more as an anchor rather than a sail?" Pittston Co., announced it would revert back to its non-tracking stock structure because its coal division was dragging down its other, more healthy divisions. This brings up many interesting conflict of interest concerns for investors.

While the two stocks are managed by the same Board of Directors, the stockholders are not necessarily the same. In fact, they will likely be quite different. For which set of shareholders should the board seek to maximize value? Both the tracking stock and the parent stock are tapping into the same pool of resources. If the tracking division begins to flag or seems to be an unsuccessful venture, the natural managerial decision might be to divest or at least cut back on investment. However, this would cause the tracking stockholders to complain because their stock would go down in value. The question then becomes, is the job of management to maximize the value of the two stocks concurrently?

Executive compensation becomes an issue as well. Consider what might happen if the board owned a different amount or percentage of shares in the parent company when compared to the tracking stock. Might there be an incentive to place the interests of one set of stockholders above those of the other?

The stock market cannot remain bullish forever. And when it corrects, there is likely to be a tremendous backlash surrounding tracking stocks. Are tracking stocks the wave of the future or are they a law suit waiting to happen?

Questions

1. Why would the price of a firm before tracking stocks are introduced be different from the combined price of the parent and the tracking stock once the new structure is in place?

2. Why are there so many tracking stocks in the technology sector as opposed to other sectors?

3. Why is it necessary for the market to become bearish before the potential problems associated with tracking stocks get noticed?

4. For which set of shareholders should the board seek to maximize value?

5. How could executive compensation be structured to discourage favoritism of either the parent stock or the tracking stock?