Equity Transactions Research Articles

Are Private Equity Investors Boon or Bane for an Economy?-A Theoretical Analysis

In this paper, we provide a theoretical foundation for the controversial debate on the investment behaviour of private equity investors. We separately consider six major characteristics that typically distinguish private equity investors from standard investors. Applying a simple model framework, we compare both the maximum acquisition prices paid by private equity and standard investors for the takeover of a target firm, as well as the subsequent optimal investment volumes. This analysis intends to uncover why private equity investors do (or do not) acquire a company even though they later invest less than standard investors would. We find that most of the usual arguments against private equity transactions, such as higher target return, short‐term investment perspective, lower risk aversion, and operational improvements, cannot explain lower investment volume following a successful takeover by private equity firms, in contrast to other arguments, such as high level of leverage and informational advantages.

Fund Managers Under Pressure: Rationale and Determinants of Secondary Buyouts

The fastest growing segment of private equity deals are secondary buyouts - sales from one PE fund to another. Using a comprehensive sample of leveraged buyouts we investigate whether SBOs are value-maximizing, or reflect opportunistic behavior. To proxy for adverse incentives, we develop buy and sell pressure indexes based on how close PE funds are to the end of their investment period or lifetime, their unused capital, reputation, deal activity, and fundraising frequency. We report that funds under pressure engage more in SBOs. Pressured buyers pay higher multiples, use less leverage, and syndicate less suggesting that their motive is to spend equity. Pressured sellers exit at lower multiples and have shorter holding periods. When pressured counterparties meet, deal multiples depend on differential bargaining power. Moreover, funds that invested under pressure underperform.

Corporate Governance and Value Creation: Evidence from Private Equity

Using deal-level data from transactions initiated by large private equity houses, we find that the abnormal performance of deals is positive on average, after controlling for leverage and sector returns. Higher abnormal performance is related to improvement in sales and operating margin during the private phase, relative to that for quoted peers. General partners who are ex-consultants or ex–industry managers are associated with outperforming deals focused on internal value-creation programs, and ex-bankers or ex-accountants with outperforming deals involving significant mergers and acquisitions. The findings suggest the presence, on average, of positive but heterogeneous skills at the deal-partner level in large private equity transactions.

Editor’s Letter

1. F. John Mathis 1. Editor Private equity assets under management have surpassed $3 trillion, of which just over $2 trillion is unrealized portfolio value and slightly over $1 trillion is dry powder—according to the latest quarterly report by preqin. At the same time, private equity deal

Ageing, Difference and Discrimination: Property Transactions in the Crucible of Human Rights Norms

The question of group-based human rights for older people, rooted in recognition of their specific vulnerabilities, has come under the spotlight in recent years. The emergence and intensification of an international debate concerning the role of human rights norms in addressing difference and discrimination linked to ageing has culminated in the campaign for a new international convention on the rights of older people, to mirror existing group-based conventions relating to the rights of women, children and people with disabilities. At the same time, the demographic and socio-economic implications of the ‘ageing society’ have coincided with a political and policy context rooted in asset-based welfare to generate a new environment of risk around property transactions that utilise housing equity after retirement. These parallel discourses invoke competing images of the older person as a vulnerable legal subject and as a self-responsible autonomous consumer. While these tensions have to some extent been played out in debates concerning public service provision, the domain of private, market-based property transactions to liquidate housing equity (which now dominates welfare provision for older owners) has been almost exclusively underpinned by a narrative of self-responsible individualism. This paper explores the issues surrounding differential vulnerabilities as they affect older owner’s housing equity transactions, and reflects on alternative strategies to develop a coherent theoretical framework for older owners’ legal subjectivity.

Macroeconomic effects of an equity transaction tax in a general-equilibrium model

The paper studies the impact of an equity transaction tax (ETT) on financial and real variables in a DSGE model with two types of financial frictions: (1) financial intermediaries facing a leverage constraint; (2) noise shocks that lead to the emergence of non-fundamental equity trade. The ETT depresses the demand for equity and hence increases the cost of capital; this then affects firms' investment decisions. In the long run, the tax is found to be as distortive as a corporate income tax. The transaction tax also reduces volatility in financial markets, but the impact on real volatility is limited.

Drivers of Value Creation in a Secondary Buyout: The Acquisition of Brenntag by BC Partners

Purpose – While secondary buyouts have gained in importance in recent years, specific drivers of value creation of this type of private equity deal are not yet well understood. Through the in-depth analysis of the acquisition of Brenntag by BC Partners, we develop propositions on the value creation profile in secondary buyouts. Design/methodology/approach – We use a single case study design to explore the information-rich context of a secondary buyout. The Brenntag case epitomizes the development of a company from being part of a large conglomerate to being private equity owned after the primary and secondary buyout up to being publicly listed. Our analysis is based on nine semi-structured interviews with key protagonists and the analysis of primary company data as well as additional secondary data sources. Findings – We propose that even if the investment management and monitoring skills of the primary and secondary private equity group are similar there is still the potential to realize operational improvements in a secondary buyout due to either an early exit of the primary private equity group or measures that further enhance management incentivisation. Furthermore, the Brenntag case shows that low information asymmetries can lead to higher leverage and that opportunities for multiple expansion are limited in secondary buyouts.Originality/value – While a secondary buyout has been a common exit route in recent years, we are the first to undertake an in-depth case analysis of a secondary buyout. Our study helps researchers and practitioners to enhance their understanding of drivers behind the value creation profile of secondary buyouts.

Performances of Brazilian IPOs backed by private equity

Private equity funds invest actively. According to the literature, their portfolio companies maintain superior transparency standards and corporate governance practices, such as keeping independent board members and hiring international auditing firms. Private equity funds require either a controlling interest or restrictive clauses to limit managerial action and usually appoint the executives of their portfolio companies. Brazil faced an IPO wave that started in 2004 and peaked in 2007. Many private equity deals went public. The aim of this paper is to investigate whether private equity backed IPOs performed better in the long run (1year) than non-private equity backed IPOs. We examine the one-year cumulative abnormal returns (CAR) of 108 Brazilian IPOs from January 2004 to June 2008, including 42 PE backed IPOs. We split the sample into two calendar periods: 2004–2006 and 2007–2008, and we find that PE backed IPOs have higher average CAR than non-PE backed IPOs in both periods. However, PE backed IPOs issued during 2007–2008 were not immune to the 2008 world economic crisis and investments in the smallest companies are the ones most severely affected. Regression analysis confirms that PE investment has a positive relation to CAR, but only for IPOs issued in 2004–2006.

What happens in acquisitions?: Evidence from brand ownership changes and advertising investment

We study advertising at the brand level in a sample of corporate acquisitions. New owners display an elevated propensity to sharply cut advertising in acquired brands. This behavior is most pronounced in private equity transactions. When a buyer's existing brands overlap with the acquired brands, aggregate advertising spending on the merged portfolio of brands tends to shift downward. Sharp advertising cuts are more likely to be observed when the old owner of the assets was investing at an elevated level and when the new owner has displayed past restraint in their investment spending activities. Combined buyer and seller abnormal returns are more positive in deals characterized by post-acquisition cuts in advertising, suggesting that these cuts often represent efficiency-enhancing cost savings.

Why Do Firms Go Private in Australia?

Information asymmetry and valuation factors are important considerations in a private equity transaction. In this study we analyze the importance of information asymmetry vis-a-vis undervaluation as a determining factor in going private transactions in Australia. Using a unique hand collected dataset and matched-sample of firms from 1990 to 2010, we develop and test a predictive choice model. Our empirical results show that market undervaluation, rather than information asymmetry per se, is the dominant factor in firms going private. Our results are robust to alternative measures of valuation. Further, we find that institutional holding is a significant deterrent for private equity investment decision.

Interview with Herta von Stiegel, author of The Mountain Within

Purpose – The purpose of this article is to provide an interview with Herta von Stiegel, author of The Mountain Within.

Private Equity and Its Regulation in Europe

In the fifteen year period to 2008, the private equity industry grew enormously in Europe, to the point where it began to be seen as a rival to the public markets. This gave rise to concerns and calls for the private equity industry to be regulated. The financial crisis, and in particular the contraction of the market for debt prompted by the collapse of Lehman Brothers in September 2008, has led to a significant reduction in the number and value of private equity deals. However, if anything, the financial crisis has led to increased calls for regulation of the industry. This paper examines the development of private equity transactions in Europe, and analyses the nature of these transactions. It then considers whether the concerns raised in relation to private equity are justified. Broadly, the arguments in favour of regulation of private equity may be divided into two kinds: the need to increase transparency in the industry by imposing disclosure obligations, and systemic risk concerns. These arguments are considered, and the terms of the Alternative Investment Fund Managers Directive (AIFMD) are examined in the light of these issues. It is argued that the arguments in favour of regulation of private equity are weaker than has been suggested and that this Directive does not adequately differentiate between hedge funds and private equity when imposing this regulatory regime.

Performance of Institutional Trading Desks: An Analysis of Persistence in Trading Costs

Using a proprietary dataset of institutional investors' equity transactions, we document that institutional trading desks can sustain relative performance over adjacent periods. We find that trading-desk skill is positively correlated with the performance of the institution's traded portfolio, suggesting that institutions that invest resources in developing execution abilities also invest in generating superior investment ideas. Although some brokers can deliver better executions consistently over time, our analysis suggests that trading-desk skill is not limited to a selection of better brokers. We conclude that the trade implementation process is economically important and can contribute to relative portfolio performance. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Which Firms Benefit from Strengthening Contract Enforcement? Foreignness as an Asset at Exit in Emerging Economies Private Equity

This paper explores how the value of foreignness is affected by institutional change over the life of private equity (PE) deals in emerging economies. I find that strengthening formal contracting institutions actually lower returns for deals managed by internationally experienced PE firms from OECD countries, while the effect on investments held by emerging economy PE firms is relatively more positive. The separation between local and foreign PE firms is not explained by differences in investee revenue growth, which is negatively affected by institutional change across the board. But separation is explained, at least in part, by the greater value of foreign resources like global buyer contacts and reputation when formal contracting is weaker at the time of final sale.

Book Reviews

Book Reviews

Sweat equity: principle, procedure and right recipients in India, United States and Japan

Purpose – The issuance of sweat equity shares has recently created controversies. The limitations backing the conservatism of sweat equity shares issuance can be ascribed to confabulating recipient recognition process, uneasy tax treatment and procedural inconsistencies. This paper aims to study the theoretical and legal underpinnings, rightful recipients and the procedure for issuing sweat equity shares.Design/methodology/approach – The authors choose the jurisdictions of India, the USA and Japan to study the problems plaguing issuance of sweat equity shares. The USA's prototypical reference and burgeoning technical soundness coupled with the sound venture capitalism of India and Japan has inspired the choice. The regulatory regime subsisting in the above jurisdictions governing sweat equity is studied comprehensively and comparatively. The structuring of sweat equity transactions and the tax treatment of sweat equity shares in the USA, India and Japan are discussed.Findings – It is found that due to the...

Die Bestimmung Des Unternehmenswertes Konventioneller Mikrofinanzbanken Ohne Börsennotierung Anhand Von Kundenlebenswerten Unter Berücksichtigung Von Handlungsflexibilität (Valuation of Microfinance Banks)

It is becoming increasingly important to determine the value of microfinance banks, since they are subjected to a growing number of equity transactions. The present dissertation at Johann Wolfgang Goethe University in Frankfurt (Germany) examines valuation methods for microfinance banks and uses the customer lifetime value as data base for a modified DCF method. In a further step real options are included in the valuation to demonstrate that flexibility has a value for microfinance banks too.

Informed Trading and the Market Reaction to Accounting Restatements

ABSTRACTWe examine how informed trading activities affect the market reaction to accounting restatements. We find significantly less negative reactions to accounting restatements when managers are net purchasers of stock before the restatement, and significantly more negative market reactions when managers are net sellers. Similar patterns characterize corporate trading, where prior stock repurchases dampen negative reactions and prior equity issuances increase negative reactions to the restatement. We address the possibility of reverse causality in which informed trades are undertaken because of the expected market reaction by examining the difference between disclosed and non-disclosed trades, finding that the market reaction is concentrated in the disclosed trades. Our results are incremental to general return patterns associated with insider trading and corporate equity transactions, and hold after controlling for other determinants of the market reaction to restatements. Taken together, these findings suggest that investors use informed trading activities to help interpret and price accounting restatements.JEL Classifications: M41, M42.Data Availability: Data are publicly available from the sources identified in the study.

The Law and Finance of Broker-Dealer Mark-Ups

The prices charged retail customers by broker-dealers for less-liquid, lower-priced securities have been of long-standing regulatory concern. In particular, the National Association of Securities Dealers (succeeded now by the Financial Industry Regulatory Authority) has long had regulations prohibiting broker-dealers from charging excessive “mark-ups” and “mark-downs.” This paper, using a unique dataset generously provided by the National Association of Securities Dealers tracking some 161,635 equity transactions involving fourteen broker-dealers and retail customers in largely less liquid, lower-priced securities over the course of the 2003-2005 period, provides the first comprehensive analysis of the determinants of the mark-ups and mark-downs charged by broker-dealers. In particular, the effect of broker-dealer solicitation, broker-dealer participation in the trade as a principal, stock price volatility, stock price level, trade volume and the bid-ask spread are examined on the size of mark-ups and mark-downs charged. This analysis is placed in the context of the law on mark-ups and mark-downs.

Asset Sales and the Role of Buyers: Strategic Buyers versus Private Equity

We model bidding behavior and the interaction of private equity and strategic buyers in corporate asset sales. Private equity bidding and in turn seller gains, and type and time of exit, are determined by private equity's ability to enhance the asset's value. Our empirical results show excess returns to sellers are greater for sales to private equity than strategic buyers. Seller gains in private equity deals are related to subsequent increases in asset values and type and time of exit. Value increases during private equity ownership significantly exceed those of benchmark firms.