Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs

Owen A. Lamont and Richard H. Thaler
University of Chicago and National Bureau of Economic Research

Recent equity carve-outs in U.S. technology stocks appear to violate a basic premise of financial theory: identical assets have identical prices. In our 1998–2000 sample, holders of a share of company A are expected to receive x shares of company B, but the price of A is less than x times the price of B. A prominent example involves 3Com and Palm. Arbitrage does not eliminate this blatant mispricing due to short-sale constraints, so that B is overpriced but expensive or impossible to sell short. Evidence from options prices shows that shorting costs are extremely high, eliminating exploitable arbitrage opportunities.

I.

Introduction

There are two important implications of the efficient market hypothesis. The first is that it is not easy to earn excess returns. The second is that prices are “correct” in the sense that prices reflect fundamental value. This latter implication is, in many ways, more important than the first. Do asset markets offer rational signals to the economy about where to
We thank John Cochrane, Douglas Diamond, Merle Erickson, Lou Harrison, J. B. Heaton, Ravi Jagannathan, Arvind Krishnamurthy, Mark Mitchell, Todd Pulvino, Tuomo Vuolteenaho, an anonymous referee, and seminar participants at the American Finance Association, Harvard Business School, the National Bureau of Economic Research Asset Pricing meeting, and the University of Chicago finance lunch for helpful comments. We thank Joe Cornell and Mark Minichiello of Spin-off Advisors for data and helpful discussions. We thank Frank Fang Yu for excellent research assistance. Lamont gratefully acknowledges support from the Alfred P. Sloan Foundation, the Center for Research in Security Prices at the University of