Tracking stock

Tracking stock

Best defined with an example. Suppose Company A purchases a business from Company B and pays B with 1 million shares of A's stock. The agreement provides that B cannot sell the 1 million shares for 60 days, and also prohibits B from hedging by purchasing put options on A's shares or short-selling A's shares. B is worried that the market may fall in the next 60 days. B could hedge by purchasing put options or selling the futures on the S&P 500. However, it is possible that A's business is much more cyclical than the S&P 500. One solution to this problem is to find a tracking stock. This is a stock that has high correlation with A. Let us call it Company C. The solution is to sell short or buy protective put options on this tracking stock C. This protects B from fluctuations in the price of A's stock over the next 60 days. Because the degree of the protection is related to the correlation of A and C's stock, it is extremely unlikely that the protection is perfect. Multidivisional firms have used a form of restructuring called tracking stock since 1984 to segment the performance of a particular division -- similar to a spin-off or carve-out, except that the parent firm does not relinquish control of the tracked division. Previously, this was known as alphabet stock, but the technically correct name is tracking stock (e.g., EDS traded for years as a tracking stock of GM). This is a way to reward managers for good divisional performance with an equity that is tied to their division-rather than potentially penalizing them compensation for bad performance in a division they have no control over.

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tracking stock

A common stock that provides holders with a financial interest in a particular segment of a company's business. Essentially, a tracking stock is a proxy for the value of the subsidiary if it were independent and publicly traded. Tracking stocks are generally issued by corporations that feel their firms are not being fully valued by investors.

Case Study In April 2000 General Motors Corporation offered owners of its $1 ²/₃ par value common stock an opportunity to exchange each of their shares for 1.065 shares of the firm's class H common stock. The company stated it would accept tenders of up to 86,396,977 shares, or approximately 14% of its outstanding common stock. Class H common was a tracking stock designed to provide holders with financial returns based on the financial performance of GM subsidiary Hughes, which General Motors would continue to control. Dividends to class H shareholders depended on the portion of Hughes's earnings allocated to the class H stock. Hughes's earnings were to be allocated based on a formula that incorporated the proportion of the class H stock outstanding (rather than held by GM). Dividends on class H stock were to be determined by the directors of General Motors. Owners of the class H shares had no claim on the assets of Hughes. Rather, they had rights in the assets of General Motors as common stockholders of GM, not Hughes. At the time of the exchange the company stated that GM directors had no plans to pay dividends on the class H shares in the foreseeable future. It also warned that under certain circumstances the class H shares were subject to being recapitalized into shares of the $1 ²/₃ par value common stock. In other words, GM shareholders who exchanged for the class H stock might be forced to convert back to the same stock they had given up in the initial exchange. General Motors later put its Hughes subsidiary up for sale.

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Tracking stock. Some corporations issue tracking stock, a type of common stock whose value is linked to the performance of a particular division or business within a larger corporation rather than to the corporation as a whole.

Tracking stock separates the finances of the division from those of the parent company, so that if the division falters or takes time to become profitable, the value of the traditional common stock won't be affected.

If you own tracking stock, you actually are invested in the parent company, since it continues to own the division that's being tracked, though typically you have no shareholder's voting rights in the corporation.