Tracking Stock

What Is A Tracking Stock?

Tracking Stock refers to shares issued by companies that pay a dividend based on the performance of a designated portion or division of the company. It is typically a class or series of common stock. They are also known as targeted stocks.

Stockholders hold equity in the parent company, not the specific entity the stock represents. They receive payment subject to the issuer's operations risks. Companies with diverse divisions often establish tracking stocks to enable investors to own a specific division and monitor shareholder interest. Companies may issue a targeted stock when the market undervalues successful divisions.

• Tracking stocks are shares issued by parent companies, which are not specifically the ones representing the stocks. They pay dividends based on the performance of a designated portion or division of the company.
• The dividend payments of the stock are based on the performance of the tracked division or segment companies issuing tracking stocks must comply with the SEC's registration and reporting requirements.
• There are different types of such stocks, including equity and asset tracking stocks.
• Tracking or targeted stocks provides flexibility, capital-raising opportunities, and increased transparency for investors but may have disadvantages, such as uncertainty about voting rights and complexities in corporate governance.

Tracking Stock Explained

A tracking stock is a common stock that relies on the financial performance of a particular business unit within a company rather than the company as a whole. These stocks are traded as separate securities, and their value can fluctuate independently of the overall company's performance. Shareholders of targeted stock have a financial stake solely in the specific unit or division and typically possess limited or no voting rights. When the company is liquidated, the stock shareholders can’t make any legal claims to the company's properties.

The amount paid as the dividend of a tracking stock is based on the performance of the business division or unit. The Securities and Exchange Commission (SEC) imposes registration and reporting requirements on such stocks similar to those for any company issuing a new class of common stock. Regarding public offerings, these stocks must be registered under the Securities Act of 1933 unless exempted.

Spinoffs are a similar concept. A parent corporation can detach the financial performance of a business unit or subsidiary from its primary activities by targeted stocks and spinoffs. Although they do not confer ownership, tracking stocks indicate a financial stake in the tracked company. To create a distinct, independent firm, spinoffs entail the parent company giving shares of the subsidiary to current shareholders.

Features

The salient features of tracking or targeted stock are:

• Voting Rights: Tracking stockholders generally have voting rights, which may either be fixed at the issuance or floating, meaning they can be periodically adjusted based on relative market values.
• Dividend Rights: These stock portfolios offer dividend rights based on the tracked business earnings. The dividend policy, including the timing and distribution of earnings from the tracked business, is at the discretion of the issuer's Board of Directors (BOD).
• Liquidation Rights: Tracking stockholders do not possess special rights regarding the tracked assets but instead possess a share issuer's assets. Liquidation rights often depend on the relative values of the tracked and total assets on the issuance. However, they can also be fixed proportionally immediately prior to liquidation to the relative market capitalization.
• Conversion Rights: The issuer typically has the option to convert the stock or the these stock portfolios, often at a premium, into another class of stock, subject to some restrictions. Sometimes, the tracked stock converts to the other class automatically if the issuer sells the tracked assets. In other scenarios, conversion may be one of several available options.

Types

The types of tracking or targeted stock are given as follows:

#1 - Equity Tracking Stock

These are those stocks that a parent company issues to monitor the performance of a particular business unit or subsidiary that the parent company either wholly or partially owns. Although they do not directly own the subsidiary or business sector, investors who own equity type of these stocks are entitled to the profits and assets of the tracked enterprises.

#2 - Asset Tracking Stock

A parent company may issue asset monitoring stocks to monitor the performance of a particular class of assets, including real estate, investments, or intellectual property. Investors can experience the performance of the assets without really owning them by purchasing these stocks.

Examples

Let us look into a few examples to understand the concept better.

Example #1

Let us say Daisy Corporation, a technology conglomerate, creates a tracking stock called Daisy Tech to represent the performance of its technology division. Investors can now buy shares of Daisy Tech. Targeted stock prices may rise or decline based on the financial performance of that specific division. The stock prices are different from parent stocks. This allows investors specifically interested in the technology sector to invest in Daisy Corporation with a targeted focus.

Example #2

Sony Communications Network Corp. had raised $67.8 million by selling tracking stock for its Internet division. The company, which priced the unit's shares at $22.16, in the middle of its goal range, is the first in Japan to provide targeted stocks. The stock, which began trading on the Tokyo Stock Exchange on June 20, 2001, was planned to be used to track Sony Communications' performance.

Advantages And Disadvantages

Some of the disadvantages and advantages of these stocks are as follows:

Advantages

#1 - Flexibility In Business Reconstruction 

One key benefit is their flexibility for company restructuring. By issuing tracking stocks, a parent firm can detach the financial performance of a subsidiary or business division from its core activities. This makes it simpler to assess the tracked business and, in the future, sell or spin it off.

#2 - Capacity To Raise Funds

A parent company can also generate money by issuing tracking stocks, which preserves its ownership stake in the tracked company. Buying these stocks exposes investors to the tracked business's financial performance without giving them ownership in the subsidiary or business segment.

#3 - Increased Transparency For Investors

Investors might gain further insight into the financial performance of particular subsidiaries or company sectors by tracking equities. A parent company can give investors comprehensive financial information on the tracked business by issuing these stocks. This enables them to make better investment de cisions.

#4 - Tax Advantages

In some situations, issuing tracking stocks can help investors and the parent firms get tax benefits.

Disadvantages

#1 - Uncertainty About Voting Rights

The potential for misunderstandings over voting rights; voting rights are typically not attached to tracking stocks, and some investors could incorrectly think that they have a voice in the parent company's decisions tracked business.

#2 - Complexities In Law

Issuing tracking stocks may present legal challenges, as the parent firm must comply with the regulatory requirements for these special financial instruments.

#3 - Increased Risk Of Corporate Governance Problems

The parent company still maintains control over the tracked business. Using tracking stocks may increase the possibility of corporate governance problems. The parent company may put its interests ahead of those of the tracked firm or its investors, leading to conflicts of interest and a lack of accountability.

#4 - Constrained Liquidity

Since these stocks may not be as widely traded as the parent firm's main stock, they can suffer from low liquidity. This may make it more challenging for tracking stock investors to purchase or sell, which could result in more significant price fluctuations and volatility.

Frequently Asked Questions (FAQs)

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