Using the Capital Market as a Monitor: Corporate Spinoffs in an Agency Framework

A model is developed in which corporate spinoffs are a feature of incentive contracts for product managers in diversified firms. I argue that the possibility of a future spinoff can improve current incentives for divisional managers, even if a spinoff rarely actually occurs. Spinoff incentive policies exploit the fact that after a spinoff, the stock value of the product line is a much cleaner signal of managerial productivity than when the division belongs to the parent firm. I show that providing current incentives through such a reorganization policy can dominate standard principal-agent contracts in highly diversified firms. Empirical implications of the model are developed regarding corporate spinoff behavior and the compensation of divisional managers.