The Value of Tunneling: Evidence from Master Limited Partnership Formations

Abstract

Shareholders of publicly-traded subsidiaries are potentially susceptible to expropriation (tunneling) by parent companies (Atanasov, Boone, and Haushalter, 2010). Recent study suggests that this is particularly true among U.S. master limited partnerships (“MLPs”), where there is often substantial divergence between the control rights and cash-flow rights of parent firms, through their general partner interests (Atanassov and Mandell, 2018). Although the negative impact of tunneling on controlled firms is documented in the literature, little is known about the valuation consequences of tunneling for shareholders of parent corporations. Changes to the MLP agency environment over the prior two decades—namely, the allowance of modifications to fiduciary duty under Delaware law and the introduction of incentive distribution rights—have likely increased the incentive and opportunity for tunneling, and provide a rich setting for addressing this question. I examine the effects of changing tunneling incentives on stock returns of parent corporations announcing the formation of MLPs, and document significantly higher announcement period returns for MLP formations after these changes, amounting to roughly $188 million of additional value for shareholders of forming corporations, on average. Considered in concert with additional testing, this suggests that parent corporation shareholders benefit from the increased ability to tunnel MLP assets.

Keywords: Tunneling; Master Limited Partnerships; Equity Carve-Out; Agency Problems

JEL Classification: G30, G34, K22