18 Financial Management.Autumn 2001 eight months after their original July 1998 carve-out of Abgenix.Cell Genesys followed with a subsequent carve-out of half of their holdings.Cell Genesys was able to sell its holdings for very little discount at all to the prevailing market price.Examples like this suggest that holdings liquidity is unlikely to justify the pricing behavior. D.Agency Costs Agency costs create discounts for closed-end funds relative to their holdings when management fees are too high or if future portfolio management is expected to be sub par (Boudreaux,1973).For agency costs to explain the pricing of the Internet stock sample,the incentives of parent-firm managers must be sufficiently divisive as to destroy more than half of the value of their carve-out subsidiary's business.On a book value basis,the residual businesses are relatively large.For each event in our sample,the book value of the residual assets exceeds that of the carve-out assets.The residual value of a parent can have a negative value if the managers of the parent company extract and substantially waste cash flow provided by the subsidiary carve-out.Therefore,we wish to explore the implications for profitability.ownership,and management overlap implied by an agency-cost-based explanation of Internet carve-out pricing. Jensen's (1986)free-cash-flow argument suggests that managers of positive cash-flow- generating businesses overinvest in unprofitable assets.Thus,if parent management squanders free cash flow provided by a profitable subsidiary,investors might discount the parent-held shares in the subsidiary.If the operating cash flow in the subsidiary is negative. then the discount is not due to the free-cash-flow investment behavior of current management. To test this implication,financial statement data for the subsidiary during the period following the carve-out is examined.We use the earliest 10-K or 10-Q filing with the SEC after the carve-out and multiply quarterly income statement figures by four to estimate the annual figure.Our results are summarized in Table IlI. The carve-out subsidiary business represents a minority of the consolidated firm's operations, comprising from 3%to 27%of consolidated sales.Both subsidiary and parent operating profits (earnings before interest,tax,and extraordinary items)are negative for all four cases. The return on assets is measured by dividing the subsidiary operating loss by total contemporaneous subsidiary assets.Return on assets varies from-2%for TURF to-33%for PFSW.To examine operating margins,we divide operating profit by total revenue.The operating margins for the four Internet businesses are low,ranging from-10%for UBID to-51%for PFSW. Based on current financial statements,the sampled Internet businesses are not profitable at present. The negative operating profitability for the three Internet subsidiaries provides little evidence that the value discount of the parent companies is caused by poor use of subsidiary cash flow.Since the measures used are based on historical,not prospective,performance, this evidence does not preclude scenarios in which investors anticipate that management will squander future subsidiary cash flow.We perform additional tests of the potential for investors to expect such management incentives. Berle and Means(1932)suggest that agency costs are greater if managers own a small portion of the residual claims,since a manager who benefits little from firm value improvements has little incentive to maximize firm value.Based on this argument,agency costs will be greater if the management holdings of the parent are less than that of the subsidiary.To test this implication,managerial ownership data are collected for the parent and carve-out subsidiaries.To identify the fraction of shares beneficially held by executives and officers of the parent.we use the first proxy statement or other SEC filings after the carve-out