6 Financial Management.Autumn 2001 asset-value relation characteristic of closed-end funds.In both cases,the indirect holdings of the traded assets sell at a discount to the direct holdings.The application of traditional closed-end-fund discount explanations to the Internet carve-out pricing phenomenon is evaluated.Taxes,dilution,illiquidity discounts,and agency costs do not fully explain the magnitude and time-series characteristics of the pricing relation.Internet carve-outs tend to be held by individual investors with aggressive trading behavior and arbitrage in these shares is constrained.We conclude that an important clientele of investors places a greater value on direct asset holdings of emerging industries,such as the Internet industry,than it does on indirect holdings via the parent.Similar price behavior among non-Internet carve- outs from other emerging industries is also observed.Such findings corroborate those of Lee, Shleifer,and Thaler(1991)for closed-end funds:bullishly biased investor clientele and sufficiently large arbitrage constraints allow indirect holdings to trade at substantial discounts to direct holdings. Our findings also have strong managerial implications.The evidence supports Nanda's (1991)hypothesis of opportunistic carve-out behavior,in which parent companies choose carve-out transactions when the subsidiary is priced richly relative to the parent.In an asymmetric information setting,Nanda's firms prefer carve-outs when the subsidiary is overvalued and the parent is undervalued,and vice-versa for parent equity.Miller (1977, 1995)emphasizes that arbitrage constraints allow such opportunistic financing behavior to persist in equilibrium.Evidence by Slovin,Sushka,and Ferraro(1995)also supports findings that firms conduct carve-outs when outside investors attach higher values to the subsidiary than do managers. This paper illustrates the potential magnitude of valuation discrepancies available to managers in Nanda's setting.The evidence from our small sample does not support the much broader generalization of Vijh(1999),who uses long-run performance to argue that carve-outs are fairly priced.Vijh suggests that reputational effects may discourage parents from selling overpriced subsidiary equity,since carve-outs generally represent a small fraction of parent market value.Perhaps for emerging industries in which the potential mispricing is particularly large,the reputational effects are dominated by the immediate wealth gains to parents The paper proceeds as follows.Section I provides an overview of Internet subsidiary carve-outs in the 1990s.In Section Il,empirical tests of various traditional explanations for carve-out pricing behavior are examined.Section IlI examines in detail opportunistic timing as an explanation for the observed pricing.In Section IV,we compare the Internet industry evidence to that of other industries.Section V summarizes and concludes. I.Internet Subsidiary Carve-outs An equity carve-out is defined as an event in which the parent sells equity claims in a subsidiary through a public cash offering,but retains a majority holding in the carved out subsidiary for financial reporting,tax,or control considerations.The transaction enables the parent to raise new capital for both itself and its subsidiary by selling primary shares in the subsidiary.This process mirrors the initial public offering process of an independent company.Following the transaction,the new publicly traded subsidiary becomes a separate entity with distinct equity share certificates.Following the carve-out,investors may purchase claims on the subsidiary in two ways:directly through subsidiary shares or indirectly through the parent shares.This approach lets us test the relative pricing relation of traditional tests of"no arbitrage"pricing efficiency by comparing investor valuations of the parallel asset prices