Privately-held Firms Research Articles

Loan Commitments and Private Firms

Bank lending is an important source of funding for firms. Most loans are in the form of credit lines. Empirical studies of line demand have been complicated by their use of data on publicly traded firms, which have a wide menu of financing options. We avoid this problem by using a unique proprietary data set from a large financial institution of loan commitments made to 712 privately-held firms. We test Martin and Santomero's (1997) model, in which lines give firms the speed and flexibility to pursue investment opportunities. Our findings are consistent with their predictions. Firms facing higher rates and fees have smaller credit lines. Firms with higher growth commit to larger lines of credit and have a higher rate of line utilization. Firms experiencing more uncertainty in their funding needs commit to smaller credit lines. Almost all firms convert unused credit line portions into spot loans and take out new lines.

Slack Resources and the Performance of Privately Held Firms

Empirical findings from publicly traded firms and behavioral arguments suggest a positive influence of resource slack on financial performance. While this area has remained unexplored in privately held firms, conceptual arguments indicate that resource constraints may enhance performance. Longitudinal data on 900 privately held firms confirm the differing influences of forms of slack on performance. Results indicate that a combination of behavioral and resource constraints arguments are necessary to explain the slack-performance relationship in privately held firms. The implications of these findings for theories of resources and entrepreneurship are discussed.

The Equity Wealth Effects of Method of Payment in Takeover Bids for Privately Held Firms

In takeover bids for unlisted firms, the typically more closely-knit target shareholders have the bargaining power and incentives to force the bidder's managers to disclose their private information about the value of their firm's shares. The acceptance of share-based offers by private-target shareholders thus conveys favourable information about the net present value of the takeover, unlike the case in share-based bids for listed targets. We document that successful bids for private targets are associated with significantly positive abnormal returns to bidders over the announcement period, a result that diverges from findings based on bids for public targets. Contrary to Chang (1998), share-based bids for Australian private targets are not associated with higher abnormal returns to bidders. Most bids by listed companies for private companies are cash-based and generate a positive return. Our results are consistent with the explanation that lower competition for private targets allows acquirers to capture more of the economic rent from takeovers by offering cash bids.

Loan Commitments and Private Firms

Bank lending is an important source of funding for firms. Most loans are in the form of credit lines. Empirical studies of line demand have been complicated by their use of data on publicly traded firms, which have a wide menu of financing options. We avoid this problem by using a unique proprietary data set from a large financial institution of loan commitments made to 712 privately-held firms. We test Martin and Santomero's (1997) model, in which lines give firms the speed and flexibility to pursue investment opportunities. Our findings are consistent with their predictions. Firms facing higher rates and fees have smaller credit lines. Firms with higher growth commit to larger lines of credit and have a higher rate of line utilization. Firms experiencing more uncertainty in their funding needs commit to smaller credit lines. Almost all firms convert unused credit line portions into spot loans and take out new lines.

On the Decision to Go Public: Evidence from Privately-Held Firms

We test recent theories of when companies go public which predict that 1) more companies will go public when outside valuations are high or have increased, 2) companies prefer going public when uncertainty about their future profitability is high, and 3) firms whose controlling shareholders enjoy large private benefits of control are less likely to go public. Our analysis tracks a set of 330 privately-held German firms which between 1984 and 1995 announced their intention to go public to see whether, when, and how they subsequently sold equity to outside investors. Controlling for private benefits, we find that the likelihood of firms completing an initial public offering increases in the firm's investment opportunities and valuations. We also show that these effects are distinct from factors that increase firms' demand for outside capital more generally.

Risk, Return and Degree of Owner Involvement in Privately Held Firms

Financial theory states that the variability of an asset’s return should be explained by the relative riskiness of that asset (Sharpe, 1964). This concept has been built around, and applied to, publicly-listed companies for which market information (which forms the basis of the risk and return measures) is easily visible and obtainable. Unfortunately, the fact that such information is rarely (if ever) available for small businesses, severely limits the usefulness of such a theory for privately-held enterprises. Therefore by using data from 100 small businesses and three measures of risk, this study provides empirical evidence that for small businesses, there is no significant relationship between financial returns and risk, but there is a relationship between the level of control exerted by the owners of a firm and the financial returns of that firm. This paper also provides evidence that owners with little or no control of a firm, take action to prevent agency costs. This action is in the form of disbursements to shareholders, rather than using debt as a means of reducing agency costs.

An assessment of employee ownership in the United States with implications for the EU

The United States has developed a varied and widespread employee ownership sector. This sector has two distinct sub-sectors, the public stock market and small privately-held firms. There is a significant gap in the incidence and development of employee ownership between the European Union (EU) and the US when both sectors are examined. Socioeconmic system differences between the EU and the US suggests that EU employee ownership will be more likely to develop if the EU expands citizen participation in its public stock markets and creates legislative support for selling smaller family businesses to employees. Second, US employee ownership is deficient in direct employee participation in corporate governance. If employees are to have reasonable rights to protect their investment risk, the US will have to converge with the EU in terms of its appreciation of the co-determination rights of workers. The development of employee ownership in the US can be better understood by appreciating the subtleties of how the argument that ownership causes superior performance of employee owned firms is presented. Most employee ownership firms will use the pull model of employee ownership where the firm never makes the extreme commitments of cultural transformation that are necessary to drive better corporate performance. We expect that the push model of employee ownership will continue to be the basis of a more “utopian” image of employee ownership. The pull model of employee ownership is based on the notion that the structure of compensation has changed in modern society and corporations are increasingly looking for ways to provide modest fix wage commitments and pay AFTER performance has taken place. The collapse of the fixed wage system plays a key role in the emergence of employee ownership in the US. Research on the wealth effects of employee ownership supports the perception that employee ownership firms are more generous. It is only this evidence that creates the basis of broad public support of the idea. This last observation helps explain why employee ownership has become so popular in the United States despite the fact that it violates a common precept of investment, namely, that a diversified basket of investments are the most rational market investment. Too much US employee ownership was “bogus employee ownership” based on workers purchasing stock with their savings. To the extent the EU wants to learn about employee ownership from the US, it should not imitate these mistakes.

International Examples Of Large-Scale Systems - Theory And Practice I:Implementing ERP Systems in China

This paper reports the findings of an exploratory study of R/3 users in China which was conducted in Spring 2000. The broad purpose of the study is to identify crucial implementation process and context variables which warrant closer attention in the study of IT-enabled organizational change. As companies display a great variety of ownership structures in China (including state-owned, foreign-invested, and privately-held firms), the role of ownership can be studied in relatively greater depth there than elsewhere. While it turns out that ownership is strongly associated with implementation process characteristics, the association of ownership structures with implementation results is much less pronounced. It was found that project governance, specifically the role and decision making style of the steering committee, can be associated with a broad set of outcome variables after controlling for ownership and other important context factors.

An Analysis of Shareholder Agreements

Shareholder agreements govern the relations among shareholders in privately-held firms, such as joint ventures or venture capital-backed firms. We provide an explanation for the use of put and call options, tag-along rights, drag-along rights, demand rights, piggy-back rights, and catch-up clauses in shareholder agreements. We view these clauses as serving (1) to induce the parties to make ex ante investments, (2) to preclude ex post transfers by the party that has the ability to engage in such transfers, and (3) to achieve the efficient ex post allocation of stakes in the firm.

Small Business and Computers: Adoption and Performance

Until recently, little evidence suggested that the computer revolution of recent decades has had much impact on aggregate economic growth. Analysis at the worker level has found evidence that use of computers is associated with higher wages. Although some research questions whether this finding is solely due to unobserved heterogeneity in worker quality, others point to such results as evidence that the wage premia for skilled workers have increased over time. Adoption of new technologies is associated with higher productivity and higher productivity growth. As in the worker literature, firms adopting computers may simply be more productive firms. Using new data from the 1998 Survey of Small Business Finances, I examine the determinants of computer adoption by small, privately-held firms and analyze whether computer use affects profits, sales, labor productivity, or other measures of firm success. I am able to control for many firm characteristics not available in other data sets. I find that computer adoption is more likely by larger firms, by younger firms, by firms whose markets are national or international, and by limited liability firms. Adoption is also more likely by firms founded or inherited by a current owner and by firms whose primary owners are more educated. Firms with more than 50% of their ownership shares held by African Americans or Asians, and, in some specifications, firms with more than 50% of their shares held by Hispanics are less likely to have adopted computers, echoing results for households in the literature. Evidence concerning the link between computer use and firm performance is mixed. Current performance as measured by profits or sales is not associated with current computer use in the full sample. In some specifications, use of computers for specific tasks is associated with higher costs. Estimates of the effects of computer use on costs are larger (in absolute value) when the sample is restricted to manufacturing or wholesale trade firms or to larger small businesses. Estimates using the more parsimonious set of control variables widely available in other firm level data show large and positive effects of computer use on firm costs, sales, and profits, suggesting that controlling for managerial, firm, and owner characteristics is important.

The Equity Wealth Effects of Method of Payment in Takeover Bids for Privately Held Firms

The equity wealth effects of method of payment in takeover bids for privately held firms In takeover bids for unlisted firms, the typically more closely knit target shareholders have the bargaining power and incentive to force the bidder's managers to disclose their private information about the value of their firm's shares. The acceptance of share-based offers by private target shareholders thus conveys favourable information about the net present value of the takeover, unlike the case in share based bids for listed targets. We document that successful bids for private targets are associated with significantly positive abnormal returns to bidders over the announcement period, a result that diverges from findings based on bids for public targets. Contrary to Chang (1998), share based bids for Australian private targets are not associated with higher abnormal returns to bidders. However, most bids by listed companies for private companies are cash based and these generate a positive return. Our results are consistent with the explanation that lower competition for private targets allows acquirers to capture more of the economic rent from takeovers by offering cash bids.

On the Decision to Go Public: Evidence from Privately-held Firms

We test recent theories of when companies go public which predict that 1) more companies will go public when outside valuations are high or have increased, 2) companies prefer going public when uncertainty about their future profitability is high, and 3) firms whose controlling shareholders enjoy large private benefits of control are less likely to go public. Our analysis tracks a set of 330 privately held German firms which between 1984 and 1995 announced their intention to go public to see whether, when, and how they subsequently sold equity to outside investors. Controlling for private benefits, we find that the likelihood of firms completing an initial public offering increases in the firm's investment opportunities and valuations. We also show that these effects are distinct from factors that increase firms' demand for outside capital more generally.

Ownership Concentration and Sensitivity of Executive Pay to Accounting Performance Measures: Evidence from Publicly and Privately-Held Insurance Companies

We investigate the relation between CEO compensation and accounting performance measures in a sample of publicly- and privately-held property-liability insurance companies. We find a significant positive association between return on assets and the level of compensation for publicly-held insurers. Consistent with optimal contracting theory, we find no such relationship for privately-held insurers. We also find that the change in compensation is significantly more sensitive to the change in return on assets for publicly-held insurers than privately-held insurers. Results suggest that within privately-held firms, CEO compensation is less based on objective measures like accounting information and more on subjective measures.

Corporate Finance, Theory and Practice.

Partial table of contents: AN INTRODUCTION TO CORPORATE FINANCE The Objective Function in Corporate Finance Present Value Understanding Financial Statements Risk and Return in Practice: Estimation of Discount Rates INVESTMENT ANALYSIS Capital Budgeting Decision Rules Estimating Cash Flows Issues in Capital Budgeting Uncertainty and Risk in Capital Budgeting: Part I. The Leasing Decision THE FINANCING DECISION Market Efficiency Lessons for Corporate Finance Capital Structure: Models and Applications Capital Structure The Financing Details THE DIVIDEND DECISION A Framework for Analyzing Dividend Policy VALUATION Basics of Valuation Acquisitions and Takeovers OTHER TOOLS AND TECHNIQUES International Finance Option Pricing Theory Applications of Option Pricing Theory in Corporate Finance Risk Management Corporate Finance for Privately Held Firms.

Capital Structure Decision Making in Privately Held Firms: Beyond the Finance Paradigm

Capital structure theories grounded in the finance paradigm (agency theory, transaction cost theory) have contributed to our understanding of capital structure decision making. However, they do not address the intricacies of capital structure decision making from a managerial choice perspective, especially in privately held firms. This article brings together research from strategic management, decision sciences, and social psychology to develop a conceptual model for understanding capital structure decision making in privately held firms. In general, it is posited that capital structure decisions are influenced by the firm owner's attitude toward debt as moderated by external environmental conditions. Attitude toward debt is a function of one's belief about debt as influenced by the individual's need for control, risk propensity, experience, social norms, and personal net worth. The integration of theoretical perspectives yields eight propositions for understanding the determinants of privately held firm capital structure.

The popular strategic configuration of R&D aggressiveness and research funding in emerging biotech firms: a cluster analysis

This empirical study covering all 44 publicly-traded emerging biotech firms with annual sales less than $10M uses cluster analysis to identify strategic configurations defined by R&D aggressiveness and funding strategies that are unique to this industry. Cluster analysis shows that firms in the popular cluster, which consist of over three-fourths of firms in the study, generate at least 48 percent of their total revenue from product sales including licensing during 1988 and 1989. The extent of revenue from product sales in this industry was an unexpected finding. It is conceivable that publicly-held, small firms in this industry have more revenue from product sales than their privately-held counterparts if privately-held firms first turn public soon after creating a marketable product. The findings show that collaborative research revenue is associated with product sales in the most popular configuration. This is either due to larger firms making strategic alliances with smaller biotech firms with marketable products, or due to the success of smaller firms that are party to collaborative research agreements in creating marketable products. This needs to be researched.

On the Theory of Finance for Privately Held Firms

This paper is a first attempt at differentiating the problems of finance of the privately held small businesses from their larger counterparts. Small businesses, though not concerned with the problems and opportunities associated with publicly traded firms, have different types of complexities, such as shorter expected life, presence of estate tax, intergenerational transfer problems, and prevalence of implicit contracts. Some standard problems like agency and asymmetric information are also more complex. The relatively high transaction costs faced by small businesses in all types of financial decisions also preclude a sizable subset of available choices.

The informal venture capital market: Aspects of scale and market efficiency

Risk capital is a resource essential to the formation and growth of entrepreneurial ventures. In a society that is increasingly dependent upon innovation and entrepreneurship for its economic vitality, the performance of the venture capital markets is a matter of fundamental concern to entrepreneurs, venture investors and to public officials. This article deals with the informal venture capital market, the market in which entrepreneurs raise equity-type financing from private investors, (business angels). The informal venture capital market is virtually invisible and often misunderstood. It is composed of a diverse and diffuse population of individuals of means; many of whom have created their own successful ventures. There are no directories of individual venture investors and no public records of their investment transactions. Consequently, the informal venture capital market poses many unanswered questions. The author discusses two aspects of the informal venture capital market: questions of scale and market efficiency. The discussion draws upon existing research to extract and synthesize data that provide a reasonable basis for inferences about scale and efficiency. Private venture investors tend to be self-made individuals with substantial business and financial experience and with a net worth of $1 million or more. The author estimates that the number of private venture investors in the United States is at least 250,000, of whom about 100,000 are active in any given year. By providing seed capital for ventures that subsequently raise funds from professional venture investors or in the public equity markets and equity financing for privately-held firms that are growing faster than internal cash flow can support, private investors fill gaps in the institutional equity markets. The author estimates that private investors manage a portfolio of venture investments aggregating in the neighborhood of $50 billion, about twice the capital managed by professional venture investors. By participating in smaller transactions, private investors finance over five times as many entrepreneurs as professional venture investors; 20,000 or more firms per year compared to two or three thousand. The typical angel-backed venture raises about $250,000 from three or more private investors. Despite the apparent scale of the informal venture capital market, the author cites evidence that the market is relatively inefficient. It is a market characterized by limited information about investors and investment opportunities. Furthermore, many entrepreneurs and private investors are unfamiliar with the techniques of successful venture financing. The author's scale and efficiency inferences, coupled with evidence documenting gaps between private and social returns from innovation, prompt questions about public as well as private initiatives to enhance the efficiency of the informal venture capital market. The article concludes with a discussion of Venture Capital Network, Inc. (VCN), an experimental effort to enhance the efficiency of the informal venture capital market. VCN's procedures and performance are described, followed by a discussion of the lessons learned during the first two years of the experiment.

The Structure of Ownership and the Theory of the Firm

The separation of ownership from control produces a condition where the interests of owner and of ultimate manager may, and often do, diverge, and where many of the checks which formerly operated to limit the use of power disappear.... In creating these new relationships, the quasi-public corporation may fairly be said to work a revolution. It ... has divided ownership into nominal ownership and the power formerly joined to it. Thereby the corporation has changed the nature of profit-seeking enterprise.1