Management Buyouts Research Articles

Company metamorphosis: professionalization waves, family firms and management buyouts

We explore the process of professionalization pre- and post-buyout (MBO) or buyin (MBI) of former private family firms using longitudinal evidence from six UK family firms undergoing an MBO/I in 1998. Professionalization behaviour was monitored up to 2014. Previous studies have conceptualized professionalization as a threshold to be attained. We demonstrate that professionalization is a complex process occurring in waves, triggered by changes in firm ownership and management. Waves of professionalization converge during the MBO/I process. Buyouts provide a funnelling mechanism enabling diverse control systems to be standardized. Post-MBO/I, divergence in the professionalization process reoccurs contingent on firm-specific contexts. Professionalization focuses on operations when stewardship relationships predominate, but on agency control mechanisms when there is increased potential for agency costs. Buyout organizational form is an important transitory phase facilitating the professionalization process. Professionalization is not a once-for-all development stage.

Are Target Shareholders Systematically Exploited in Management Buyouts and Freezeouts?

We provide evidence that managers and controlling shareholders time MBOs and freezeout transactions to take advantage of industry-wide undervaluation. Portfolios of industry peers of MBO and freezeout targets show significant alphas of around 1% per month over the first twelve months following the transaction. These returns are not explained by a battery of risk-factors, including a takeover-risk factor. In contrast, abnormal returns are not observed following arms-length third-party acquisitions. Investors appear to be unaware of the industry-wide undervaluation when the MBO or freezeout bid is announced. Target shareholders receive bid premiums comparable to those of arms-length third-party acquisitions, and industry peers of MBO and freezeout targets have insignificant returns around the announcement.

Opening the Black Box: Power in Buyout Negotiations and the Moderating Role of Private Equity Specialization

The management buyout is an important exit strategy for small business owners. Negotiations of buyout deals have received little research attention to date. This is surprising given buyout negotiations' complexity giving rise to multiple issues that require consideration and often conflicting interests of deal parties. This paper examines perceived bargaining power in buyout negotiations between private equity (PE) firms and current owners who sell their business. We identify competition, expertise, and time pressure as key antecedents of PE firms’ perceived bargaining power and examine the moderating effect of PE firms' industry and size specialization in buyout negotiations. We use a sample of 176 respondents who each report on a particular buyout deal for a PE firm. The majority of respondents are seasoned PE professionals who held managing director or investment director positions.

Deal Process Design in Management Buyouts

Management buyouts (MBOs) are an economically and legally significant class of transaction: not only do they account for more than $10 billion in deal volume per year, on average, they also play an important role in defining the relationship between inside and outside shareholders in every public company. Delaware courts and lawyers in transactional practice rely heavily on “market check” processes to ensure that exiting shareholders receive fair value in MBOs. However, this Article identifies four factors that create an unlevel playing field in that market check: information asymmetries, valuable management, management financial incentives to discourage overbids, and the “ticking clock” problem. Because this taxonomy of four factors is mutually exclusive and collectively exhaustive, it allows special committees and their advisors to assess the degree to which the playing field is unlevel in an MBO. This Article then identifies more potent deal process tools that special committees can use to level the playing field: e.g., contractual commitments from management that allow the board to run the process; pre-signing rather than post-signing market checks; information rights rather than match rights; ex ante inducement fees; and approval from a majority of the disinterested shares. This Article also identifies ways that the Delaware courts can encourage the use of these more potent devices when appropriate, through the threat of entire fairness review and the application of Revlon duties. The result would be improved deal process design in MBOs and improved capital formation in the economy overall.

Evidence of Downward Real Earnings Management from Corporate Events

​Prior studies of real-activity earnings management (REM) focus on earnings-inflating abnormal activities. We seek to establish the existence of downward REM by investigating several corporate events in which managers have incentives to temporarily deflate market valuations. Specifically, we focus on, and find downward REM before, share repurchases, management buyouts (MBOs), and CEO option awards. Large-sample evidence of downward REM is also found in our general analysis of earnings smoothing. Downward REM becomes much smaller or nonexistent when there is a lack of managerial incentives in those events, such as non-carry-through repurchases, incomplete MBOs, and unexpected option awards. Following the research design of Zang (2012), we find that various REM and AEM cost factors consistently influence the magnitude of downward REM and AEM around the three corporate events.

Do managers manipulate earnings prior to management buyouts?

To address the question as to whether managers intending to purchase their company by means of a levered buyout transaction manipulate earnings in order to buy their firm on the cheap, we study the different types of earnings management prior to the transaction: accrual management, real earnings management, and asset reserves revaluation. To identify the management engagement incentives, we contrast earnings management in management buyouts (MBOs) with that in (i) institutional buyouts (IBOs) and (ii) non-buyout firms. We find: (i) strong negative earnings management via both accrual and real earnings activities in MBOs supporting the above management engagement incentive, (ii) modest negative accrual management and insignificant real earnings manipulation in IBOs, and (iii) positive earnings management in non-buyout firms. Asset revaluation in MBOs is not a frequently used channel. We do not find evidence that a high external borrowing need in the levered transactions mitigates the downward earnings manipulation in MBOs. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real earnings management in MBOs, but increased the relative use of real earnings management as this may be harder to detect.

Management Buy-out Pricing Model: A Fairness Preference Perspective

In order to determine the effective and reasonable management buyout price, considered of asymmetric infor- mation, this paper investigated the shareholders' decision-making behavior during the management buyout pricing proc- ess under a fairness preferences perspective. The conclusions in this paper were�1) The greater the value of the option, the smaller the critical probability of management buy-out success, namely smaller posteriori probability of the original shareholders to the management; and 2) MBO share is affected by inequity aversion. In order to enhance utility, manage- ment with higher degree of inequity aversion would increase the probability of cheating and moral hazard. The contribu- tions of this paper were: the signal display principle of option value has been found; and studied the fairness preference during the process, psychological disutility produced by fairness preference has a crowding-out effect on managerial own- ership's incentive contracts.

Evidence for the Existence of Downward Real-Activity Earnings Management

Prior studies of real-activity earnings management (REM) focus on earnings-inflating abnormal activities. We seek to establish the existence of downward REM by investigating several corporate events in which managers have incentives to temporarily deflate market valuations. Specifically, we focus on, and find downward REM before, share repurchases, management buyouts (MBOs), and CEO option awards. Large-sample evidence of downward REM is also found in our general analysis of earnings smoothing. Downward REM becomes much smaller or nonexistent when there is a lack of managerial incentives in those events, such as non-carry-through repurchases, incomplete MBOs, and unexpected option awards. Following the research design of Zang, we find that various REM and accrual-based earnings management (AEM) cost factors consistently influence the magnitude of downward REM and AEM around the three corporate events.

Financial crisis, leveraged buyouts and reverse ratchet effect

It is obvious that the current economic and financial crisis is neither the first, nor the last, that crisis occurs for multiple reasons, but that it is rare for a crisis to resemble exactly the previous one. As such, it is necessary to try to protect oneself from the crisis in general and the next crisis in particular. The current crisis is a crisis of private consumption, first affecting consumers of durable goods and a crisis of public debt. It may be that the following one will be a crisis of production, concerning more directly the firms. What struck many experts, with this crisis, is the articulation of the currency, the capital and the debt. But can we be sure, now, that all is quite clear with this problem? We answered 'no' and we wanted to show how very simple operations, like the leverage effect or the leveraged management buyout, can have serious consequences and lead to crisis. But in the particular case of leveraged transactions, there are in some cases, as opposed to speculative operations, some safeguards in the form of ratchet effect. A bit like a fire that takes on dramatic proportions or fizzled, LBOs can either be a catalyst for crisis or have no effect on it. This is what we will try to deepen.

Management Buy-Outs a Hollywood Movie with a Great Ending?

Management buy-outs (MBOs) are one segment of business that could make a great movie. The reason being that in many occasions they consist of the drama of tough and tense negotiations as well as the stress of trying to raise a great deal of money. As if this was not enough, there is a nerve-wracking race to meet the ostensibly unattainable deadline. If one adds to all the above the philanthropic aspect that management buy-outs have in honoring loyal staff and preventing unemployment then it has all it needs to comprise a great movie. However, management buy-outs are (generally) risky to finance through a loan so there are two other forms that this funding can take. Namely, vendor financing and financing via Private Equity. The latter is imperative for the purposes of this article as it refers to finance provided by either institutions or individuals while in return they will receive shares in the company and in this way influence its strategy.This article will demonstrate that MBOs is not at all an easy process and thus some issues should be thought of very seriously before it is carried on. In doing so, we will discuss the key legal issues and their connection with core commercial considerations paying particular attention to corporate control and financial structure. The main question which is answered in this paper is Success for Whom? Since an MBO could have different interpretations as to its success or failure from different viewpoints.

Who monitors the monitor? The use of special committees by target firms in corporate takeovers

This paper extends the corporate governance literature such as Alchian and Demsetz (1972) by analyzing the use of special committees of disinterested directors by target firms during corporate takeovers. Our sample spans post Sarbanes–Oxley from 2003 through 2007, under which boards of directors are subject to increased scrutiny and additional regulatory mandates. This period is also characterized by a high level of management buyout activity that can exacerbate conflicts. Our results show that special committee use is positively related to conflicts and negatively related to factors and situations where insider knowledge is particularly valuable. Moreover, the propensity to form a committee is negatively related to the board's overall independence; hence special committees substitute for the monitoring not found in the overall board composition. Special committees, on average, are formed well in advance of the merger agreement, employ additional financial advisors, and are more likely to run an auction process. Target returns in deals with special committees are no different than deals without special committees. The evidence indicates that special committees enable target boards to adapt to situational conflicts, which helps explain when independent directors matter for corporate governance.

Mergers and acquisitions in Germany

This article gives a general overview of private and public mergers and acquisitions (MandA) deals under German law. The term MandA applies to all types of corporate acquisitions, including management buy-outs, joint ventures or public takeovers. Deals can be divided into two categories: private MandA deals, where the seller and the potential purchaser directly negotiate the transfer of the company, or (ii) public MandA deals, in which the a listed public company is acquired in accordance with the public takeover rules.

VC investments and global exits

This paper examines exits of UK venture capital backers (VCs) from portfolio companies around the world. Mergers and acquisitions (M&A) are the most frequently used exit route for all investments, both in the UK and abroad. Exit through M&A is particularly common for investments in the UK while the probability of an exit through an initial public offering (IPO) is substantially lower for investments made in the UK than abroad. We are able to explain these country differences in terms of variations in the characteristics of VCs, portfolio companies, legal systems and market conditions. Portfolio companies backed by experienced VCs have high probabilities of exits through M&A or IPO. A successful exit is more likely when a VC syndicate includes an experienced member. The likelihood of a successful exit through M&A, IPO or management buyouts is high in countries with, and at times of, high stock market liquidity. Legal systems that provide more investor protection facilitate exits through IPO or M&A.

中東欧のEU新規加盟国とユーロ

First, this paper considers the impact of the global financial crisis on new EU Member States (NMS) from Central and Eastern Europe. In the case of Slovenia, the best performer among the NMS, the situation has been very serious. Second, the mechanism of the crisis in Slovenia is examined in detail. Since the EU accession in May 2004, especially the adoption of the ERM II in June in the same year, in the financial area barriers between the Eurozone economy and the Slovenian economy practically disappeared. The sovereign risk premium decreased. Domestic banks borrowed a huge amount of funds at international wholesale financial markets and actively financed companies’ ambitious investments. Financial authorities in the country were not alert to cross-border movement of a huge amount of capital. Due to the Lehman shock, however, international financial markets became tight suddenly and demands in the Western markets sharply decreased. The direction of international financial flows reversed. The banking sector was obliged to dispose a huge amount of non-performing loans and recorded negative pre-tax profit for consecutive three years since 2010. One of the reasons why the Slovenian economy fell into such a serious crisis is that domestic banks increased their borrowings abroad too quickly within a short time from 2005 through 2008. In addition, there were the following circumstances: 1) the second wave of privatization of state-owned companies was implemented on the method of Management Buyout from 2006 and domestic banks gave loans to managers. Unfortunately, this was done immediately before the Lehman shock; 2) the weight of foreign-owned banks has been smaller in this country. In other NMS foreign-owned banks have been predominant in the banking sector, and their parent banks managed to support their affiliates in the global financial crisis. In contrast, in the case of Slovenia, the government has been required to inject fresh capitals into domestic banks to protect the banking system. The type of Slovenian crisis is different from that of the Greek crisis and the Cypriot crisis. Finally, the paper considers the significance of euro for NMS from Central and Eastern Europe. The NMS, which have not adopted euro yet, will sooner or later advance toward the adoption of euro. After joining the Eurozone, these countries will be required to steer their economic policies cautiously on the basis of lessons from Slovenia’s failure.

SMBOs: Buying Time or Improving Performance?

On the basis of an empirical analysis of 491 UK recent secondary management buyouts (SMBOs), we find strong evidence of a deterioration in long‐run abnormal returns following SMBO deals. SMBOs also perform worse than primary buyouts in terms of profitability, labor productivity, and growth. We find no evidence for superior performance of private equity (PE) backed SMBOs, compared with their non‐PE‐backed counterparts. It appears that a PE firm's reputation and change in management are important determinants of improvements in profitability and labor productivity, respectively. High debt and high percentage of management equity tend to be associated with poor performance measured by profitability and labor productivity. Notably, none of the buyout mechanisms (i.e., financial, governance, operating) normally associated with performance improvements generate growth during the secondary buyout phase. The results are robust to the use of alternative performance measures, alternative benchmarks, and the possibility of sample selection bias. Copyright © 2013 The Authors. Managerial and Decision Economics published by John Wiley & Sons, Ltd.

Do Managers Manipulate Earnings Prior to Management Buyouts?

To address the question as to whether managers manipulate accounting numbers downwards prior to management buyouts (MBOs), we implement an industry-adjusted buyout-specific approach and receive an affirmative answer. In UK buyout companies, negative earnings manipulation (understating the earnings prior to the deal) often occurs, both by means of accrual management and real earnings management. We demonstrate that MBOs are significantly more frequently subject to negative manipulation than leveraged buyouts (LBOs). In non-buyout firms, positive earnings management frequently occurs because it affects managers’ bonuses and the likelihood of meeting or beating analysts’ expectations which may trigger a positive market reaction. By means of an instrumental variables approach, we examine competing incentives affecting the degree and size of earnings manipulation. Our evidence implies that the (ex ante) perceived likelihood that an MBO will be undertaken has a strong significant effect on negative earnings management, while the external borrowing capacity of the buyout company is not determined by standard capital structure factors, such as earnings numbers. The implementation of the revised UK Corporate Governance Code of 2003 has somewhat reduced the degree of both accrual earnings and real management in MBOs, but since then other manipulation techniques (related to production costs and asset revaluations) are more frequently used, which may be induced by the fact that these manipulation methods are more difficult to detect.

An agency theoretic analysis of value creation through management buy-outs of family firms

Family firms without able and willing family successors are frequently sold to non-family managers through management buy-outs (MBOs). Whether MBOs create value is thought to be dependent upon the ability to reduce owner–manager agency costs. In this article we examine the agency costs of MBOs that acquire family firms. We contribute to theory by arguing that in such situations, value creation by reducing agency costs will depend upon pre-MBO agency costs, the ability to solve the double agency problem, and the relationship between the cost of agency control mechanisms and the residual losses from opportunism before and after the MBO.

Profiting from gaizhi: Management buyouts during China’s privatization

During the late 1990s, China introduced the gaizhi process for privatizing state-owned firms. Under gaizhi, insiders could acquire their firms at a price that was based on recent profitability. This gave the managers of firms an incentive to reduce short run profits. We compared the performance of firms acquired by their managers to performance at matched control firms. Insider controlled firms experienced a significant decrease in profitability immediately prior to privatization and a return to pre-gaizhi profits soon thereafter. The short term reduction in profits was accompanied by a decrease in labor productivity, an increase in overdue accounts receivable, and an increase in R&D investment. We do not observe a similar pattern among firms acquired by outsiders. These findings suggest that insiders intentionally suppressed the performance of their firms so as to acquire them at less than fair value.

When Do Managers Seek Private Equity Backing in Public-to-Private Transactions?*

Managers have the choice to take the firm private themselves in a management buyout or to seek private equity backing. We argue that managers seek private equity backing in case they are more constrained to finance the deal themselves. We confirm the hypothesis using a sample of UK public-to-private transactions over the period 1997–2003. A post going private performance analysis reveals that both management buyouts and private equity backed deals outperform their industry peers. However, private equity backed deals outperform their peers already before the deal takes place whereas management buyouts improve performance afterwards. This suggests a passive role for private equity firms in going private transactions.

Do Investors Understand ‘Operational Engineering’ before Management Buyouts?

During the year prior to management buyout (MBOs) announcements, target firms exhibit abnormally high discretionary expenses in selling, general and administration, abnormally low discretionary accruals, and realize losses from asset sales. Higher discretionary expenses and losses from asset sales are associated with lower pre-MBO abnormal stock returns, especially for firms with higher insider ownership, less board and institutional monitoring, and higher information asymmetry. They are also associated with better post-MBO operating performance. None of these activities affects the likelihood of MBO deal completion, announcement period abnormal returns, or offer premium. These target firms do not show such abnormal activities in other years before the MBOs or after the MBOs. Our results suggest that outside investors and the market do not fully understand the earnings-reducing activities before MBOs.