What is Tracking Stock?

The Government of India had constituted Dr. JJ Irani Expert Committee to make recommendation on the Concept Paper on Company Law and committee had recommended in its report for the introduction of ‘Tracking Stocks’ in the Indian Capital Market.

A Tracking Stock is a type of Common stock that tracks or depends on the financial performance of a specific business unit or operating division of a company, rather than the operation of the company as a whole. As a result, if the unit or division performs well, the value of tracking stocks may increase, even if the company’s performance as a whole is not up to mark or satisfactory. The opposite may also be true.

A tracking Stock is a special type of stockists used by a publicly held company to track value of one segment of that Company. By issuing a tracking stock, the different segment of a company can be valued differently by investors. Tracking stocks are generally issued by a parent company in order to create a financial vehicle that tracks the performance of a particular division or subsidiary. When a parent company issues a tracking Stock, all revenue and expenses of the applicable division are separated from the parent company’s financial statements and bound to the tracking stock. Often this is done to separate a high – growth division from large losses shown by the financial statements of the parent company. The parent company and its shareholders still control operations of the subsidiary.
Tracking stock carries dividend right tied to the performance of a targeted division without transferring ownership or control over divisional assets. In contrast to a spin-off or an equity carve-out, the parent retains full control, allowing it to enjoy any operating synergies, or economies of scale in administration or finance.

Shareholders of tracking stocks have a financial interest only in that unit or division of the company. Unlike the common stock of the company itself, a tracking Stock usually has limited or no voting rights. In the event of a company’s liquidation, tracking stock shareholders typically do not have a legal claim on the company’s assets. If a tracking stock pays dividends, the amount paid depends on the performance of the business unit or division. But not all tracking stock pays dividends.

A company has many good reasons to issue a tracking stock for one of its subsidiaries (as opposed to spinning it off to shareholders).

1. First of all, the company keeps control over subsidiary although they don’t get all the profit, but all revenue and expenses of the division are separated from the parent company’s financial statements and attributed to tracking stock. This is often done to separate a high growth division with large losses from the financial statements of the parent company.

2. Second, they might be able to lower their hosts of obtaining capital by getting a better credit rating.

3. Third, the businesses can share marketing, administrative support functions, etc.

4. Finally, if the tracking stock shoots up, the parent company can make acquisitions and pay in stock of subsidiary instead of cash.

When a tracking Stock is issued, the company can choose to sell it to the markets or to distribute new share to existing shareholders. Either way, the newly tracked business segments get a longer lease, but can still run back to the parent company in tough times.