What Is Tracking Stock and How Does It Differ From Stock?
Learn about tracking stock, an equity investment tool that allows focus on a company's specific segment, distinct from its overall common stock.
Equity investments allow individuals to participate in the financial success of businesses. Companies structure their ownership in various ways to raise capital and align investor interests. This involves issuing different types of securities, each with unique characteristics and implications for both the company and its investors.
Defining Tracking Stock
Tracking stock is a specialized class of common stock issued by a parent company. This type of stock is designed to reflect the financial performance of a specific division, subsidiary, or business unit within that parent company, rather than the consolidated results of the entire corporation. For example, a large technology firm might issue a tracking stock for its cloud computing segment.
Despite its focus on a specific unit, tracking stock remains legally an equity interest in the parent company, not a direct ownership stake in the division itself. Its purpose is to allow investors to gain exposure to a particular part of a larger enterprise without that part being spun off as a separate legal entity.
How Tracking Stock Works
The value of tracking stock is intended to be derived from the financial performance of the specific business unit it tracks. This includes factors such as the division’s revenues, profits, and asset valuations. However, the tracking stock’s performance can also be influenced by the overall financial health and market sentiment of the parent company. The parent company maintains separate accounting records for the tracked division, which provides transparency into its specific revenue streams and profitability.
If dividends are paid on tracking stock, they are usually linked to the earnings or cash flow generated by the tracked unit. This provides investors with a direct benefit from the business unit’s accomplishments. Tracking stock trades separately on stock exchanges, distinct from the parent company’s common stock. This allows for independent market valuation of the specific segment.
The parent company retains legal ownership and operational control over the underlying assets and management of the tracked division. Its board of directors typically makes decisions that affect the tracked unit’s operations. Although tracking stock aims to reflect a division’s performance, the parent company can still allocate profits or costs between divisions, which may impact the tracking stock’s value. Companies must include financial statements about the tracking stock in their reports to regulatory bodies like the U.S. Securities and Exchange Commission (SEC).
Reasons for Issuing Tracking Stock
Companies issue tracking stock for several strategic reasons, often to unlock perceived value within a diversified corporate structure. One primary motivation is to highlight the potential of a high-growth or distinct division that might be undervalued within the broader company. This allows the market to assign a more precise valuation to that specific segment. Issuing tracking stock can attract investors who are specifically interested in a particular industry or sector.
This financial tool enables a parent company to retain control over a division while still giving it separate equity appeal. It can be a way for companies to raise capital targeted for a specific division, funding its expansion or innovation, without needing to sell off part of the business or engage in a full spin-off. Companies might also use tracking stock as a form of acquisition currency, particularly when acquiring a business that aligns well with the tracked division. Tracking stock can also serve as an incentive for employees of a specific unit, tying their equity compensation directly to the performance of their particular business segment.
Key Differences from Common Stock
Tracking stock differs from traditional common stock in several important aspects. Common stock typically reflects the performance of the entire company, meaning its value is tied to the consolidated financial results of all business units. In contrast, tracking stock is designed to mirror the financial performance of a specific division or business unit within the parent company. This allows investors to gain targeted exposure to a particular segment.
Regarding voting rights, common stock usually carries full voting rights, allowing shareholders to influence corporate governance and elect the board of directors. Tracking stock, however, often comes with limited or no voting rights for the parent company’s board or general corporate matters. While some tracking stocks may have fixed or floating voting rights, their influence is generally restricted to decisions affecting the tracked division.
Both common stock and tracking stock represent equity in the parent company. Common stockholders have a claim on the entire company’s assets in the event of liquidation. Tracking stockholders, while holding an equity interest in the parent, do not have a direct legal claim on the assets of the tracked division; their claim remains on the parent company’s overall assets. This means tracking stock investors could still be exposed to the liabilities of the parent company. Common stock is the primary form of equity issued by a company, whereas tracking stock is a specialized class created for specific strategic purposes.