What it is:
A tracking stock is a security that is issued to track the performance of a wholly-owned subsidiary.
How it works (Example):
A large, diversified company may issue a tracking stock based on one of its wholly-owned subsidiaries. The company may do this because it believes that the subsidiary's performance will be very different (much better) than the parent company. The use of tracking stocks was a relatively common strategy employed by companies during the technology growth boom of the 1990s. Parent companies would launch subsidiaries based on new products and services, such as Internet service companies. Because these "spin-offs" were stripped of the diseconomies of scale and cost centers within the parent company's operations, their stock performance was expected to soar.
Examples of tracking stocks were The Walt Disney Company's wholly-owned subsidiary "go.com." Other examples include regional branches of national cell phone operators. Eventually, most tracking stocks are absorbed by the parent company as the operations and the tracking stock's performance come into line with the parent's stock.
While the tracking stock is based on the subsidiary's financial performance, it is legally and financially bound to the parent company. For accounting purposes, while the financial performance of the tracking stock company is reported separately, it is ultimately consolidated within the parent company's financial statements