Divestments and financial distress in leveraged buyouts

This paper investigates the wealth effects of 134 divestments by 41 firms that underwent leveraged buyouts in the 1980s. Stock in these companies is privately owned. Bond returns for publicly traded debt are used to measure the wealth effects of the divestment announcement. These divestments are, on average, not associated with significant wealth effects for the full sample. However, firms that experience financial distress have negative and significant abnormal returns associated with their divestments, while returns in non-event months are insignificant. In contrast, non-distressed firms gain when asset sales are announced. The losses suffered by bondholders in distressed sellers are large and significant when core assets are divested. Bondholders in these firms do not suffer significant losses when non-core assets are divested. Finally, abnormal bond returns are related to the structure of the firms' post-buyout debt. Returns are negatively related to the use of private debt in the capital structure and positively related to the use of subordinated debt.     

Small Firm Capital Structure and the Syndicated Loan Market

We show that small firms using syndicated loans for their mid- and long-term financial needs have significantly higher leverage than firms that do not borrow in this market. This difference cannot be attributed to firm characteristics like the availability of growth opportunities, asset tangibility, R&D spending, profitability and net sales that are known to influence capital structure. We also find that the capital structure of other firms that borrow in the syndicated loan market is not different from those that do not. We show that already highly leveraged small firms are more likely to borrow in the syndicated loan market than other firms. The higher debt in the capital structure of small firms that rely on syndicated loans consequently can be attributed to the availability of capital rather than demand for capital, as shown more generally by Faulkender and Petersen (Rev Financ Stud 19(1):45?C79, 2006).     

What Happens During the Private Period?: Evidence from Public‐to‐Private Reverse LBOs

This study provides new evidence on the restructuring activities undertaken by public‐to‐private reverse leveraged buyouts (RLBOs) while owned by private equity firms. The authors' comprehensive sample of public‐to‐private LBOs that return to public ownership through IPOs enables them to observe changes in profitability, valuation, financial structure, operating structure, and cost structure from the time the firms go private through (and after) their emergence through (re‐) IPOs. With their exclusive focus on reverse LBOs involving public‐to‐private deals, the authors reach findings that contradict previous conclusions about RLBOs. At the time of the LBO, the target firms in reverse LBOs are more levered than their peers, pay higher dividends, and are more profitable than their peers. At the same time, however, they appear to have lower market valuations before the buyouts. During the private period, the target firms of reverse LBOs achieve significant increases in employee productivity, asset restructuring, and improved gross margins, while operating with substantially higher levels of debt financing, lower levels of cash and working capital, and greater concentration of equity ownership. After the companies return to public ownership through IPOs, such companies continue to operate with higher leverage and ownership concentration than their publicly traded peers while producing further increases in profitability, resulting in substantial increases in both enterprise and equity valuation. The authors' analysis also shows that higher debt levels from the buyout play an important role in increased enterprise values. The evidence suggests that possible undervaluation as well as expected efficiency gains from restructuring actions are the primary motives for such reverse LBOs.     

Real asset liquidity,cash holdings,and the cost of corporate debt

We study the impact of the interplay between cash holdings and asset sales on the corporate debt spread. We allow cash holdings and asset sales to assist with both debt repayment and sequential investments. The interplay between cash holdings and asset sales leads to a convex relationship between credit spreads and the liquidity of the market for real assets. We use the 2008 financial crisis as a natural experiment and find that post-2008, the nonlinearity of the link between credit spreads and asset liquidity is pronounced, closely matching analytical predictions. This is especially acute for highly leveraged and low profitability firms.     

IS THE BOOK‐TO‐MARKET RATIO A MEASURE OF RISK?

We develop a leverage‐based alternative to traditional asset pricing models to investigate whether the book‐to‐market ratio acts as a proxy for risk. We argue that the book‐to‐market ratio should act as a proxy because of the expected relations between (1) financial risk and measures of capital structure based on the market value of equity and (2) asset risk and measures of capital structure based on the book value of equity. We find no relation between average stock returns and the book‐to‐market ratio in all‐equity firms after controlling for firm size, and an inverse relation between average stock returns and the book‐to‐market ratio in firms with a negative book value of equity.     

股票流动性对公司资本结构的影响研究

本文分析了流动性对公司资本结构的影响。理论分析表明,一个公司股权交易流动性的提高,使得公司股权融资成本得以降低,公司更倾向于采用增发、配股等股权融资的方式融资,这会降低公司的财务杠杆率。同时,借鉴资本结构动态调整的思想分析,发现个股流动性越高,资本结构的调整速度越快。本文基于2002—2010沪深两市发行的非金融业A股数据,采用面板数据回归等方法研究了股票流动性等因素对公司资本结构的影响,本文的经验结果支持这一理论假设。     

The Case for Secondary Buyouts as Exit Channel

Do private equity firms have a clear pecking order when deciding on exit channels for their portfolio companies? Are secondary buyouts—that is, sales to other PE firms—always an exit of last resort? And are there company‐ or market‐related factors that have a clear and predictable influence on decisions to pursue secondary buyouts? Using a proprietary dataset of over 1,100 leveraged buyouts that exited in North America or Europe between 1995 and 2008, the authors attempt to answer these questions by analyzing the returns associated with public, private, and secondary (or “financial”) exits. Based on their analysis of the realized returns, there is no clear pecking order of exit types. Secondary buyouts deliver rates of return that are the equal of those achieved through public exits. In addition, the authors assess the relationship between the likelihood of choosing a financial exit and certain company‐related as well as market‐related factors. Portfolio companies with greater debt capacity are more likely to be sold in secondary buyouts. Furthermore, increases in both the liquidity of debt markets and the amount of undrawn capital commitments to the private equity industry increase the probability of exit through secondary buyouts.     

The Silent Majority: Private U.S. Firms and Financial Reporting Choices

This study uses a comprehensive panel of tax returns to examine the financial reporting choices of medium-to-large private U.S. firms, a setting that controls over $9 trillion in capital, vastly outnumbers public U.S. firms across all industries, yet has no financial reporting mandates. We find that nearly two-thirds of these firms do not produce audited GAAP financial statements. Guided by an agency theory framework, we find that size, ownership dispersion, external debt, and trade credit are positively associated with the choice to produce audited GAAP financial statements, while asset tangibility, age, and internal debt are generally negatively related to this choice. Our findings reveal that (1) equity capital and trade credit exhibit significant explanatory power, suggesting that the primary focus in the literature on debt is too narrow; (2) firm youth, growth, and R&D are positively associated with audited GAAP reporting, reflecting important monitoring roles of financial reporting; and (3) many firms violate standard explanations for financial reporting choices and substantial unexplained heterogeneity in financial reporting remains. We conclude by identifying opportunities for future research.     

What drives leverage in leveraged buyouts? An analysis of European leveraged buyouts’ capital structure

This paper examines leverage in European private equity‐led leveraged buyouts (LBOs). We use a unique, self‐constructed sample of 126 European private equity (PE)‐sponsored buyouts completed between June 2000 and June 2007. We find that determinants derived from classical capital structure theories do not explain leverage in LBOs, while they do drive leverage in a control group of comparable public firms. Rather, we document that leverage levels in LBOs are related to the prevailing conditions in the debt market. In addition, our results indicate that reputed private equity sponsors use more debt and that secondary buyouts have higher leverage levels.     

Callable or convertible debt? The role of debt overhang and covenants

We analyze what role debt overhang and covenants have in a manager’s choice between issuing callable or convertible debt when a firm needs to issue a substantial amount of debt. Callable bonds provide a higher coupon in exchange for a repurchase option. Convertible bonds offer bondholders the option to exchange debt to equity. Using a dynamic capital structure model with investment choice, we find that callable debt implies a larger debt overhang friction, and for highly leveraged firms convertible debt is preferred. Moreover, if outstanding bonds have net-worth covenants attached, callable bonds are more likely to be issued. Our empirical findings support the theory.     

The Impact of Dividends, Debt and Investment on Valuation Models

The reliability of a basic earnings and equity model of value is tested using 8,287 cases drawn from UK industrial and commercial firms reporting during 1987–1995. A respecification of this model is used to investigate the value relevance of dividends, capital structure and capital expenditure. Both the dividend and capital expenditure signals appear to be significant and the impact of the former is surprisingly strong. There is no convincing evidence that equity value is affected by the level of debt. Further investigation of dividends confirms that they are less influential in large firms or in firms with high return on equity.     

THE EFFECTS OF SPIN-OFFS ON CORPORATE INVESTMENT AND PERFORMANCE

We examine characteristics of firms involved in spin-offs and test whether these spin-offs induce changes in investment incentives and economic performance. We find that firms engaging in spin-offs are larger, more highly leveraged, and have higher asset turnover and lower real asset growth than their industry rivals. We also find that spin-offs generate significant increases in real asset growth and cash flow margin on sales for combined firm measures (spun-off firm plus parent firm). The gains result from increases in real asset growth for parent and spun-off firms, and improvements in cash flow margin on sales for parents. Our evidence is consistent with models in which spin-offs create value by improving investment incentives and economic performance.     

CAPITAL STRUCTURE MANAGEMENT AS A MOTIVATION FOR CALLING CONVERTIBLE DEBT

Using a matched-pairs methodology, we present empirical evidence of systematic changes within a corporation that are associated with calls of convertible debt. We find that calling firms experience significantly greater growth than noncalling firms in the same industry, as measured by retained earnings and long-term debt. Also, the converted debt provides a significant source of new book equity, and calling firms issue significantly less other new equity. The pattern of growth in balance sheet accounts is consistent with the pecking order hypothesis and supports the notion that some firms call convertible debt to reduce their total cost of obtaining additional external financing. The evidence also shows that, on average, calling firms experience a significant decline in their leverage ratio based on book value but no significant change in their leverage ratio based on market value of equity. This is consistent with the call's being used as part of the firm's management of its capital structure.     

Exchange Rate Exposure at the Firm and Industry Level

Previous work on the exposure of firms to exchange rate risk has primarily focused on U.S. firms and, surprisingly, found stock returns were not significantly affected by exchange‐rate fluctuations. The equity market premium for exposure to currency risk was also found to be insignificant. In this paper we examine the relation between Japanese stock returns and unanticipated exchange‐rate changes for 1,079 firms traded on the Tokyo stock exchange over the 1975–1995 period. Second, we investigate whether exchange‐rate risk is priced in the Japanese equity market using both unconditional and conditional multifactor asset pricing testing procedures. We find a significant relation between contemporaneous stock returns and unanticipated yen fluctuations. The exposure effect on multinationals and high‐exporting firms, however, is found to be greater in comparison to low‐exporting and domestic firms. Lagged‐exchange rate changes on firm value are found to be statistically insignificant implying that investors are able to assess the impact of exchange‐rate changes on firm value with no significant delay. The industry level analysis corroborates the cross‐sectional findings for Japanese firms in that they are sensitive to contemporaneous unexpected exchange‐rate fluctuations. The co‐movement between stock returns and changes in the foreign value of the yen is found to be positively associated with the degree of the firm's foreign economic involvement and inversely related to its size and debt to asset ratio. Asset pricing tests show that currency risk is priced. We find corroborating evidence in support of the view that currency exposure is time varying. Our results indicate that the foreign exchange‐rate risk premium is a significant component of Japanese stock returns. The combined evidence from the currency exposure and asset pricing analyses, suggests that currency risk is priced and, therefoe, has implications for corporate and portfolio managers.     

Bank Debt,Flexibility, and the Use of Proceeds from Asset Sales

In the theory of financial intermediation, bank debt is often characterized as being more readily renegotiable than public debt. Banks are also conjectured to gain valuable non-public information through closer monitoring. Given these features, bank debt can theoretically be more flexible than public debt and can lead to better investment/liquidation decisions. We investigate this possibility using a sample of firms facing the important decision of whether to reinvest the proceeds from asset sales or whether to distribute the proceeds to debtholders. While higher levels of leverage are associated with an increased probability of distributing proceeds to creditors, this relationship is significantly muted for bank debt as opposed to public debt. This finding is consistent with the conjecture that bank debt provides enhanced flexibility when compared to public debt. Further we find that asset sale announcement period abnormal stock returns are increasing in firms’ use of bank debt, but not public debt. This suggests that market participants believe that banking relationships are leading to better decision making for this particular type of investment/liquidation decision. We find no significantly different effects of bank vs. public debt on the initial decision to undertake an asset sale in the first place. Thus, in the context of asset sales, the main observable difference arises in the use of proceeds decision, rather than the initial asset sale decision.     

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.     

资产专用性与公司资本结构——来自中国制造业股份有限公司的经验证据

交易成本经济学视角下的公司融资理论指出,债务与权益应该视为不同类型的“治理结构”,而这种治理结构的具体选择又主要取决于公司资产专用性。我们以2001—2003年我国制造业股份有限公司为研究对象,运用多元线性回归计量模型实证表明,公司资本结构与资产专用性和盈利能力负相关,但公司盈利能力与资产专用性正相关。因此,公司资本结构的决策不仅要考虑公司资产投资具有专用性的特点,而且还要考虑其自身的盈利能力,才可能在激烈的产品市场竞争中获得可持续竞争优势与优良绩效。     

Sources of Financing,Profitability and Productivity: First Evidence from Matched Firms

This paper contributes to the literature on capital structure and firm performance. Using firm‐level data covering over 11,000 firms from 47 countries over a recent period of 1997‐2007, we address the effect of different sources of financing on corporate performance, employing a matching process, which allows an adequate `like‐for‐like’ comparison between high and low level of financing by firms. Robust to different matching estimators, the main findings are consistent with the theories of capital structure, in that firms with high debt‐to‐equity ratio tend to have lower returns to shareholders (profitability) and lower internal efficiency (productivity). The results become more robust when we separate the firms into advanced and emerging country‐groups or countries with high/low levels of financial development. Given the lower level of leverage below 50% on average in emerging markets (or in countries with lower level of financial reforms), firms in these economies face lower risk of financial distress and thereby less adverse effect on firm profitability and productivity, relative to their counterparts in advanced economies. We also find that retained earnings and equity financing improve performance, while debt financing by firms particularly in the form of bank loans leads to lower performance, although not so in the case of debt raised through issuing bonds.     

The Capital Structure of PE‐Funded Companies (and How New Debt Instruments and Investors Are Expanding Their Debt Capacity)

The capital structures and financial policies of companies controlled by private equity firms are notably different from those of public companies. The concentration of ownership and intense monitoring of leveraged buyouts by their largest investors (that is, the partners of the PE firms who sit on their boards), along with the contractual requirement of PE funds to return their capital within seven to ten years, have resulted in capital structures that are far more leveraged than those of their publicly traded counterparts, but also considerably more provisional and “opportunistic.” Whereas the average U.S. public company has long operated with roughly 30% debt and 70% equity, today's typical private‐equity sponsored company is initially capitalized with an “upside‐down” structure of 70% debt and just 30% equity, and then often charged with working down its debt as quickly as possible. Although banks supplied most of the debt for the first wave of LBOs in the 1980s, the remarkable growth of the private equity industry in the past 25 years has been supported by the parallel development of a new leveraged acquisition finance market. This financing innovation has led to a general movement away from a bankcentered funding base to one comprising a relatively new set of institutional investors, including business development corporations and hedge funds. Such investors have shown a strong appetite for new debt instruments and risks that banks have been unwilling or, thanks to increased capital requirements and other regulatory burdens, prohibited from taking on. Notable among these new instruments are second‐lien loans and uni‐tranche debt—instruments that, by shifting the allocation of claims on the debtor's cash flow and assets in ways consistent with the preferences of these new investors, have had the effect of increasing the debt capacity of their portfolio companies. And such increases in debt capacity have in turn enabled private equity funds—now sitting on near‐record amounts of capital from their limited partners—to bid higher prices and compete more effectively in today's intensely competitive M&A market, in which high target acquisition purchase prices are being fueled by a strong stock market and increased competition from corporate acquirers.