Corporate spin-offs as a value enhancing technique when faced with legal liability

The formation of spin-off companies by corporations facing unlimited liability exposures (e.g., oil spill liability by oil transport and oil production firms) is shown mathematically to actually increase shareholder wealth and firm value. This increase occurs at the expense of the liability claimants who essentially must absorb the cost of a put option on the value of the limited liability feature obtained by spinning off the company (a stop-loss type insurance premium). In addition to discussing this issue, the paper provides illustrations from current pollution liability history and considers differences between the stockholder/bondholder incentive conflicts and the stockholder/ liability claimant conflicts.