Explanation of Tracking Stock

A tracking stock differs from a traditional stock because it does not reflect the performance and financial condition of the entire company. A tracking stock is a special type of security that is created when a parent company chooses to issue an investment that represents a specific division of the company. The parent company and the shareholders continue to maintain control of the entire company. Tracking stock is an additional separate stock. Therefore, this stock “tracks” or reflects the performance of the particular business unit it represents and not the company as a whole.

Benefits of Tracking Stock

There are several business reasons to issue this type of security. The most common situation is when the stock outperforms the company as a whole. This provides an opportunity for a company to issue an attractive stock to potential investors,  while at the same time, increasing the wealth of the business. It is common for the tracking stock to outperform the parent company stock. Another benefit is that an attractive investment can offset the negative effects of other poor performing units. This could also improve the overall parent company performance and stock.

Common vs. Tracking Stocks

Typically, shareholders of common stock generally have voting rights regarding certain policy and Board of Directors issues. Since tracking stock does not represent the entire company, it has limited voting rights. Another common feature shareholders often have is an entitlement to receive dividends based on the number of shares they owned. Of course, the amount of the distribution is tied to the performance of the company as a whole. For this reason many tracking stocks do not pay dividends. However, when a tracking stock does pays a dividend, the amount is based on the performance of the business unit the stock represents and not the entire company.

Risk of Owning Tracking Stocks

In a worst-case scenario, when a company is forced to liquidate, creditors, bondholders and stockholders have a legal claim to the assets of the company. There is a predetermined order in which claims are settled. If all the assets are distributed to first claimants, the rest do not receive anything. The general practice is that bonds and preferred stockholders claims are paid before common stock. Tracking stock claims are in an even lesser position than regular common stock.  Tracking stockholders do not have a legal claim to company assets. Therefore, in the event a company goes out of business, owners of tracking stock will not usually receive anything.

Because the value of stock is based on the overall financial performance and health of an entire company, the tracking stock is unique. It represents a particular unit of a company. Therefore, the financial results of the unit represented determine the value and performance of the tracking stock. Since this is a special unique type of security there are important differences in ownership rights, privileges and potential risks between tracking stock and other traditional types of stock.

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