[Research Seminar 2019.09.05] Free Lunches for Insiders under Investor Inertia

Abstract

This paper examines how investor inertia might benefit the controlling families of business groups in a way that is distinct from explicit tunneling or diversion of resources. Our analysis is based on a sample of new parent-subsidiary relationships created through spin-offs followed by stock-for-stock tender offers in Korean business groups. We find that family insiders actively tender their shares of the subsidiary in exchange for the new shares issued by the parent while outside investors remain largely passive. Prior to the tender offer, subsidiary prices continue to increase while parent prices drop substantially, which allows the controlling families to double their direct holdings in the parent. Families also gain 32% on overall value of their holdings, two thirds of which consists of voluntary wealth transfers by inertial investors who did not tender. Such patterns in stock prices and inertial tendencies are mitigated over time. Our results suggest that rational managers may actively exploit behavioral characteristics of investors not so much to maximize the firm value, but rather their personal benefits.