Risk hedging through forward supply contract and equity ownership in a spin-off decision

We consider the situation where a publicly traded firm is spinning off a subsidiary in order to maximize the shareholder value of the firm. To balance the underlying operational risks of the spin-off, the firm also uses a forward supply contract to hedge against the price and demand fluctuations in the future transactions of the goods produced by the subsidiary. Using an option pricing framework, we formulate a value-maximization optimization problem for selecting the best ownership structure and forward supply contract in the spin-off decision. Using our model, we present a set of numerical results to illustrate the value of a forward supply contract as an additional lever to corporate ownership structure in mitigating the operational risks induced by the underlying market uncertainty in order to maximize shareholder value. Our results provide some interesting insights for selecting the appropriate ownership structure and forward supply contract under different operating environments in a spin-off decision.