LEVERAGED BUYOUTS AND SHAREHOLDER RETURNS

This study examines the risk-adjusted stock returns realized by shareholders of firms acquired through leveraged buyouts to assess the economic gains associated with this type of acquisition. Stockholders of firms acquired through leveraged buyouts realize significant positive abnormal returns as a result of the buyout announcement. The findings support the notion of value creation in leveraged buyouts.     

The Relationship Between Market Efficiency and Insider Ownership in Large and Small Firms

The study examines insider ownership in large and small firms in relation to market efficiency. Recent studies have found a positive and significant relation between inside ownership and stock market performance. Such a finding is predicated upon the idea that inside ownership minimizes agency costs caused by the conflict between hired managers and shareholders. It is argued here that semi-strong form market efficiency requires that all public information, including insider ownership, be quickly impounded into the price of a stock. If that is the case, the expected present value of a change in agency cost should be incorporated into the stock price shortly after any significant change in ownership. Hence, if the estimate is unbiased, the longer-term performance of firms should not be effected by such changes. The issue is examined for both large, well-known firms and for smaller, less-known firms. The hypothesis that markets are generally efficient with respect to insider ownership information is rejected.     

Efficiency Gains in Unsuccessful Management Buyouts

This article uses a sample of 120 unsuccessful management buyouts (MBOs) to test whether operational improvements following successful MBOs are a result of organizational changes or private information. The findings are consistent with the organizational changes hypothesis. Firms with an unsuccessful MBO had no increase in operating performance following the buyout attempt. In addition, the cumulative abnormal stock return from before the attempted buyout until two years after the attempt is insignificantly different from 0 percent. I also find that management turnover following an unsuccessful MBO is significantly higher than normal.     

Do Buyouts (Still) Create Value?

We examine how leveraged buyouts from the most recent wave of public to private transactions created value. Buyouts completed between 1990 and 2006 are more conservatively priced and less levered than their predecessors from the 1980s. For deals with post‐buyout data available, median market‐ and risk‐adjusted returns to pre‐ (post‐) buyout capital invested are 72.5% (40.9%). In contrast, gains in operating performance are either comparable to or slightly exceed those observed for benchmark firms. Increases in industry valuation multiples and realized tax benefits from increasing leverage, while private, are each economically as important as operating gains in explaining realized returns.     

Secondary buyouts: Why buy and at what price?

This paper studies the economic logic and pricing of secondary buyouts, a form of leveraged buyout that has become increasingly popular. I investigate three potential explanations for secondary buyouts: efficiency gains, liquidity-based market timing, and collusion. The results are most consistent with the liquidity-based market timing hypothesis. Specifically, firms are more likely to exit through secondary buyouts when: the equity market is “cold”, the debt market condition is favorable, and the sellers face a high demand for liquidity. While this hypothesis shows a constrained optimal strategy for private equity firms, I do not find any strong efficiency gains for the target firms. Further, my analyses on pricing show that secondary buyouts are priced higher than first-time buyouts due to favorable debt market conditions. Overall, the results are consistent with the notion that secondary buyouts serve no purpose aside from alleviating the financial needs of private equity firms.     

THE LONG‐RUN PERFORMANCE OF COMPANIES THAT WITHDRAW SEASONED EQUITY OFFERINGS

We examine the long‐run stock price and operating performance of companies that withdraw seasoned equity offerings (SEOs). Firms that withdraw an offering provide an opportunity to examine whether markets fully adjust to the information conveyed when managers announce the intent to issue shares, independent of any agency problems that might be intensified by the completion of the offering. As in completed seasoned equity offerings, long‐horizon event‐time operating and stock price performance in sample firms is substantially lower than what is observed among control firms. Underperformance is also observed in an equally weighted calendar‐time analysis. Results are consistent with overpricing among small firms that attempt, but then withdraw, SEOs.     

Stock price informativeness on the sensitivity of strategic M&A investment to Q

Using a strategic merger sample that covers the period from 1985 to 2011, we find that the acquirer’s stock price firm-specific information, the new information created by investors about the value of firm fundamentals, increases the positive sensitivity of strategic merger investment to the acquirer’s Q; the target’s stock price firm-specific information increases the negative sensitivity of merger investment to the target’s Q. These results suggest that managers learn from financial markets in identifying strategic merger investment opportunities by transferring assets from poorly managed firms to well managed firms. In addition, the target’s stock price firm-specific information itself increases the acquisition size, indicating that informed acquirer managers are more likely to take out large merger investment. Last but not the least, stock price informativeness increases merger synergies and post-merger performance, suggesting that informed managers make better merger investment that increases shareholder value. Our study contributes to the recent increasing stream of studies on managerial learning from the market.     

Management Buyouts: Evidence on Taxes as a Source of Value

This paper estimates the value of tax benefits in 76 management buyouts of public companies completed in the period 1980 to 1986. The median value of tax benefits, estimated at the time the buyout company goes private, has a lower bound of 21% and an upper bound of 143% of the premium paid to pre-buyout shareholders. The estimated value depends on the rate buyout debt is repaid and the tax rate applied to the interest deductions. The paper also presents evidence on the actual taxes paid and debt repayment rates by these companies after the buyout. The results in this paper suggest that tax benefits are an important source of the wealth gains in management buyouts.     

Managerial incentives for discretionary disclosure: evidence from management leveraged buyouts

Managers in management leveraged buyout (MBO) firms prefer to purchase their firms at a low offer price. This motive gives them a clear incentive to make pessimistic discretionary disclosures. Using a sample of press releases, I find that managers involved in their firms’ MBO selectively release negative disclosures to denigrate their firm just before the MBO transaction when compared with prior period: they issue more bad news disclosures and more pessimistic quotes. Additionally, they issue less optimistic quotes, fewer good news disclosures, less positive earnings forecasts, and they manage earnings downwards. I control for factors that may not be caused by managers’ purchase motives by comparing the MBO sample with a third-party leveraged buyout sample where management is not involved in the buyout and with a performance-matched control sample. I find that the disclosure of MBO firms becomes significantly more pessimistic than the leveraged buyout firms where management is not involved in the transaction and significantly more pessimistic than the performance-matched control sample.     

The effect of stock price on discretionary disclosure

I examine the impact of exogenous changes in stock prices on voluntary disclosure. Specifically, I investigate whether stock price declines prompt managers to voluntarily disclose firm-value-related information (management forecasts) that was withheld prior to the decline because it was unfavorable but became favorable at a lower stock price. Consistent with my predictions, I find that managers are more likely to release good-news forecasts following larger stock price declines but that there is no association between the likelihood of releasing good-news forecasts and the magnitude of stock price increases. Additional evidence indicates that the good-news forecasts eventually conveyed by withholding firms after negative price shocks would likely have resulted in negative market reactions had they been released before the shocks. More generally, I provide evidence that managers withhold bad news and that exogenous stock price declines can induce its disclosure.     

Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases

We analyze a sample of 72 IPO firms that went public between 1992 and 1996 for which we have detailed proprietary information about the amount and cost of D&O liability insurance. If managers of IPO firms are exploiting superior inside information, we hypothesize that the amount of insurance coverage chosen will be related to the post-offering performance of the issuing firm's shares. Consistent with the hypothesis, we find a significant negative relation between the three-year post-IPO stock price performance and the insurance coverage purchased in conjunction with the IPO. One plausible interpretation is that, like insider securities transactions, D&O insurance decisions reveal opportunistic behavior by managers. This provides some motivation to argue that disclosure of the details of D&O insurance decisions, as is required in some other countries, is valuable.     

Leveraged Buyouts in the U.K. and Continental Europe: Retrospect and Prospect

The markets for management buyouts in the U.K. and continental Europe have experienced dramatic growth in the past ten years. In the U.K., buyouts accounted for half of the total M&A activity (measured by value) in 2005. And as in the U.S. during the‘80s, the greatest number of U.K. buyouts in recent years have been management‐ and investor‐led acquisitions of divisions of large corporations. In continental Europe, by contrast, the largest fraction of deals has involved the purchase of family‐owned private businesses. But in recent years, increased pressure for shareholder value in countries like France, Netherlands, and even Germany has led to a growing number of buyouts of divisions of listed companies. Like the U.K., continental Europe has also seen a small but growing number of purchases of entire public companies (known as private‐to‐public transactions, or PTPs), including the largest ever buyout in Europe, the €13 billion purchase this year of the Danish corporation TDC. In view of the record levels of capital raised by European private equity funds in recent years‐which, until 2005, exceeded the amounts invested in any given year‐we can expect more growth in private equity investment in the near future. In continental Europe, the prospects for buyouts remain especially strong, given both the pressure from investors to restructure larger corporations and the possibilities for adding value in family‐owned firms. But, as the authors note, today's private equity firms face a number of challenges in earning adequate returns for their investors. One is increased competition. In addition to the increased activity of U.S. private equity firms, local private equity investors are also facing competition from hedge funds and new entrants such as government‐sponsored operators, family offices, and wealthy entrepreneurs. Another major challenge is finding value‐preserving exit vehicles. Although an IPO is an option for the largest buyouts with growth prospects, most buyout investments are harvested either through sales to other companies or, increasingly, other private equity firms. The latter transactions, known as “secondary” buyouts, now account for a significant share of new funds invested by private equity firms across Europe.     

The real value of China’s stock market

What capital allocation role can China’s stock market play? Counter to perception, stock prices in China have become as informative about future profits as they are in the US. This rise in stock price informativeness has coincided with an increase in investment efficiency among privately owned firms, suggesting the market is aggregating information and providing useful signals to managers. However, price informativeness and investment efficiency for state-owned enterprises fell below that of privately owned firms after the postcrisis stimulus, perhaps reflecting unpredictable subsidies and state-directed investment policy. Finally, evidence from realized returns suggests Chinese firms face a higher cost of equity capital than US firms.     

Corporate Dividends and Seasoned Equity Issues: An Empirical Investigation

This paper investigates whether managers rely on dividends to obtain a higher price in a stock offering and whether the stock price reaction to dividend and offering announcements justifies such a coordination. The evidence does not support either conjecture. Issuing firms are not more likely to pay or increase dividends than nonissuing forms. Moreover, there is little evidence that firms time stock offering announcements right after dividend declarations to benefit from the attendant information disclosure. The analysis of dividend and stock offering announcement effects suggests few if any benefits from linking dividend and stock offering announcements.     

The Credibility of Voluntary Disclosure and Insider Stock Transactions

We examine stock price reaction to voluntary disclosure of innovation strategy by high‐tech firms and its relation with insider stock transactions before the disclosure. We find that, despite the qualitative and subjective nature of strategy‐related disclosure, there is positive stock price reaction to the disclosure. The evidence suggests that investors view the disclosure as credible good news. We also find that the disclosure is associated with more positive stock price reaction when it is preceded by insider purchase transactions. This evidence is consistent with insider purchase enhancing the credibility of the disclosure. The credibility‐enhancing effect is found to be stronger for firms with higher degrees of information asymmetry (younger firms, firms with lower analyst following, loss firms, and firms with higher research and development (R&D) intensity). Our evidence also indicates that predisclosure insider purchase is associated with greater future abnormal returns, suggesting that managers are privy to good news shortly before the disclosure.     

Business groups and the incorporation of firm-specific shocks into stock prices

Firm-specific information has a damped effect on business group-affiliated firms’ stock prices. Such firms’ idiosyncratic stock returns are less responsive to idiosyncratic commodity price shocks than are the idiosyncratic returns of otherwise similar unaffiliated firms in the same country and commodity-sensitive industry. Using global commodity shocks means we assess responses to common idiosyncratic shocks of the same magnitude, frequency, and observability. Further identification follows from difference-in-difference tests exploiting successful and matched exogenously failed control block transactions. We conclude that business group firms’ stock prices provide less firm-specific information to capital providers and managers.     

Economic policy uncertainty and stock price crash risk

This paper studies the impact of economic policy uncertainty on stock price crash risk using data from China. We develop a new index to measure Chinese economic policy uncertainty and find that economic policy uncertainty has a remarkable positive effect on stock price crash risk. However, the effect reverses later. The results also indicate that the positive effect of economic policy uncertainty on stock price crash risk is more prominent for state‐owned enterprises. Moreover, this effect is more prominent for firms with higher information asymmetry and firms with greater disagreement among investors, indicating that economic policy uncertainty affects crash risk through two mechanisms: managers’ concealment of bad news and investors’ heterogeneous beliefs.     

Innovation and Price Informativeness

We study whether the innovation decisions of a firm are improved as a result of information reflected in the firm's stock price. We show that firms with more informative stock prices, as measured by price nonsynchronicity, have better innovation outcomes, as measured by the number of patents and patent citations. Our results are not driven by managerial private information and are robust to various alternative specifications. We also find that price informativeness is more important to innovation when managers are less experienced or face greater uncertainty about the optimal innovation strategy, and that these effects are primarily observed in small‐ and mid‐sized firms where additional information may be of greater value. Our results are consistent with the notion that capital markets can have real effects on the economy.     

Should there exist secondary markets for executive stock options?

This paper investigates the potential disadvantages of the secondary markets for executive stock options (ESOs). The benefits of such markets are evident, but they might also have negative effects for shareholders. Executives might, for example, use inside information to time their ESO selling. We investigate two personal motives of managers that can be assumed to affect their optimal selling decision, that is, managers' personal portfolio management issues and the use of inside information. We explore these motives by analyzing unique data from Finland, where there are secondary markets for ESOs. The results of the study support the traditional portfolio diversification hypothesis according to which managers tend to sell their ESOs when holding an ESO is equivalent to holding the underlying stock; that is, in such a case a manager's wealth is closely tied to the stock price of the firm. With respect to the use of inside information the results indicate that ESO selling activity is not related to future stock price behaviour, suggesting that managers do not use inside information to determine the selling time of their ESOs. These results imply that the existence of secondary markets for ESOs does not weaken the usefulness of ESOs as the management compensation, although the benefits of such markets are evident.     

Consolidating Corporate Control: Divisional Versus Whole-Company Leveraged Buyouts

We examine the empirical relation between firm characteristics and the likelihood of choosing a restructuring choice between two types of leveraged buyouts: a whole‐company leveraged buyout (WLBO) and a divisional leveraged buyout (DLBO). Our findings suggest that firm characteristics such as volatility of cash flow and growth potential play an important role in determining a firm's restructuring choice between a WLBO and a DLBO. In particular, firms with greater volatility of cash flow and/or greater future growth potential are more likely to adopt a DLBO than a WLBO as their restructuring choice. These results are consistent with the notion that although low‐growth, high‐cash‐flow firms would create the most value for stockholders by paying out cash and tying future cash flows to the firm's debt service through a WLBO, high‐growth, low‐cash‐flow firms would be better off by selling assets if those assets would be better managed under a DLBO.