Reverse LBOs Research Articles

MILLSTEIN CENTER‐ECGI CONFERENCE ON: Board 3.0: Bringing the Private Equity Model to Public Companies

In a recent conference organized by Columbia Law School's Millstein Center and the European Corporate Governance Institute, law and econ scholars Jeff Gordon and Ron Gilson discuss with other academics and a remarkably varied and distinguished group of practitioners the possibility of “porting” elements of the private equity governance model to public companies to achieve what they describe as “Board 3.0.” The public company “monitoring” boards of the recent past—composed for the most part of part‐time, “thinly informed,” and “boundedly motivated” directors dependent upon corporate management for information about the company—are seen as evolving toward the “thickly informed, well‐resourced, and powerfully motivated” directors that Gordon and Gilson see as required to function more like “partners” in the business, helping steer management toward the long‐run value‐maximizing strategic and operating decisions.A number of the board members on the panel serve, or have served, on private as well as public companies. The consensus among this group was that PE boards function at higher levels than their public counterparts, accounting in significant part for the higher returns of PE. But as this group also noted, an ongoing “migration” of PE board members and practices to public companies, accomplished in part by reverse LBOs and PIPEs (private investments in public equity), is leading to more effective public company oversight and governance. Along with deeper specialized knowledge of critically important operational issues, PE directors are also said to have a comparative advantage in designing pay‐for‐performance incentives for operating managers. What's more, as one panelist pointed out, PE's need to focus on and prepare for “exit” from day one has the paradoxical effect of sharpening managerial attention on the long‐term future and the amount and kinds of investment needed to ensure it.

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.

Reverse LBO Underpricing: Information Asymmetry Or Price Support?

<span>Most studies attribute the underpricing of initial public offerings of equity securities to the ex ante uncertainty resulting from the information differential between the firm going public and the market. Rund (1991, 1993), however, proposes that underpricing could result from underwriter price support in the early after-market. In this paper we examine firms that were once public, went private via leveraged buyout and then went public again. It is reasonable to expect that since these reverse LBOs (RLBOs) were once publicly traded, they should have less of an information differential with the market than firms going public for the first time. Our tests indicate that there is little or no information asymmetry between RLBOs and the market. We find that RLBO initial returns are more consistent with price support than with information asymmetry.</span>

Do Firms Rebalance Their Capital Structures? Evidence from Reverse LBOs

Traditional target structure theories predict that all financing decisions move firms towards target capital structures. On the other hand, transitory debt hypothesis predicts that firms deliberately but temporarily deviate from target capital structures to fund a particular corporate action and then de-lever to re-build debt capacity. In a leveraged buyout, the maximum possible amount of debt is used to acquire the assets or stock of the target firm. This disruption in financial policy provides a laboratory to test the prediction of the transitory debt hypothesis. Our results show that firms quickly reduce their debt ratios to levels near target ratios at the time of the reverse LBO. A minority of firms in the sample increase debt significantly after the reverse LBO. In accordance with the transitory debt hypothesis, these firms value the option to borrow and decrease their debt levels accordingly so that they can preserve the option to borrow for future. When the firms have valuable investment options, they once again issue transitory debt deliberately but temporarily, they move away from their target leverage ratios, use the proceeds from the issue mainly for investment purposes, and they revert back to the target leverage levels gradually.

The Valuation Effect of IPOs: Evidence from the Bond Market

This paper examines the excess bond return in a sample of IPO announcements from 1983-2007 for firms with publicly trade debt. The main finding is that IPO announcements create a positive abnormal bond return. This finding is not driven by reverse LBOs, venture backing, spinoffs or by a reduction in leverage. This is the first paper to document a valuation effect of IPOs, which provides important new evidence on the motivation behind the decision to go public. The result is consistent with the investment and information aggregation theories and inconsistent with the market timing and diversification theories of IPOs.

The Operating Impact of Buyouts in Sweden

We analyze the magnitude and determinants of private equity sponsored buyouts9 impact on the operating profitability in Swedish buyout companies exited between 1998 and H1 2006. Whereas previous empirical studies have primarily been biased towards reverse LBOs, this article analyzes buyouts irrespective of exit type. We perform an industry adjusted event study to detect abnormal operating performance and impact on the companies9 employees. Our analysis suggests that buyouts have a significant positive impact on the companies9 operating performance. Further, we find that measurable variables commonly associated with the private equity value creation process, such as wage-level reductions, labor force restructuring, leverage and management ownership, have a low explanatory value for the magnitude of the operating impact. <b>TOPICS:</b>Private equity, developed, performance measurement, statistical methods

Earnings Management and Stock Performance of Reverse Leveraged Buyouts

AbstractThis study provides further evidence of earnings management around security offerings. We find positive and significant discretionary current accruals coincident with offerings of reverse LBOs. Issuers in the most aggressive quartile of earnings management have a one-year aftermarket return that is between 15% and 25% less than the most conservative quartile. We also find a negative and significant relation between abnormal accruals and post-issue abnormal returns within the first year after the offering. The relation remains after controlling for book-to-market ratio, firm size, offering size, and involvement of buyout specialists or management. Although earnings management has been used to explain post-issue long-term underperformance of IPOs and SEOs, our study shows that earnings management can explain post-offering returns of reverse LBOs, even in the absence of post-offering underperformance.

A Comparison of Reverse Leveraged Buyouts and Original Initial Public Offers: Factors Impacting their Issuance in the IPO Market

AbstractThe purpose of this paper is to assess the factors that affect the returns earned by investors in early trading of reverse LBOs and compare those results to factors affecting original IPOs which are matched by size, industry, and issue date. A mean excess return of 7.64% is observed for the sample of reverse LBOs during the period 1987 to 1998. This return is uniformly lower than returns earned by investing in original IPOs. These results support the information asymmetry hypothesis.The results also show that factors such as number of months the LBO was privately held, the over‐allotment, or greenshoe option, the size of the issue, insider ownership, and gross spread impact the returns earned by investors in reverse LBOs. Other factors which are known to affect returns on original IPOs, such as lead underwriter, whether the deal was syndicated, the number of managers, the listing exchange, lockup agreements, and auditor, are shown to have no impact on the returns in reverse LBOs for the sample in question. We find that the level of insider participation and the over‐allotment option are more important to original IPOs than to reverse LBOs in explaining the excess returns earned by shareholders in early trading. We find, however, that the size of the offering has more impact on excess returns for reverse LBOs than for original IPOs.

The Initial Listing Decisions of Firms That Go Public

We analyze the initial listing decisions of IPOs that qualify for New York Stock Exchange listing. We find that IPOs are more likely to list on the exchange where their industry peers are listed. Further, reverse LBOs and carveouts are more likely to choose the NYSE if the firm or their parent was previously NYSE-listed. Consistent with avoidance of delisting costs, we find that smaller, riskier firms tend to list on Nasdaq. Although direct issue costs are higher on the NYSE than on Nasdaq, total issue costs do not differ across exchanges and are unlikely to affect the listing decision. Historically, publicly held firms in the US began trading on the regional or over-the-counter markets and, in some cases, eventually moved to the New York Stock Exchange (NYSE). However, the NYSE changed its listing rules in 1983, making it easier for initial public offerings (IPOs) to meet minimum listing requirements. Now that many large IPOs could list directly on the NYSE, the initial listing decision became an important part of the IPO process. In this paper, we analyze the factors that affect the initial listing decision. We examine a sample of IPOs from 1991 to 1996 that either listed on the NYSE or met the NYSE's minimum-listing requirements, but chose to list on the Nasdaq National Market (Nasdaq). Our sample allows us to examine the initial listing decisions of firms for which NYSE listing was actually a consideration. Of the 438 IPOs that meet our sample criteria, 337 (76.9%) listed on the NYSE. The significant number of NYSE listings suggests that the change in listing rules and the NYSE's increased marketing efforts have had an important effect on the listing decisions of IPO firms. However, the fact that many NYSE-eligible IPOs continue to list on Nasdaq suggests that the perceived costs and benefits of listing vary across firms. We find that firms tend to list on the exchange where other firms in their industry are currently listed. In addition, reverse LBOs and carveouts are more likely to list on the NYSE if the firm or parent firm was listed on the NYSE prior to the LBO or carveout, respectively. These results suggest that prior exchange relationships and exchange expertise are important considerations in the choice of listing venue. Smaller, riskier firms are more likely to list on Nasdaq. This finding suggests that firms avoid expected delisting costs. The fact that small firms tend to list on Nasdaq may also suggest that sponsorship is an important factor in the listing decision. However, we find no evidence that younger firms, which would also benefit from sponsorship, are more likely to list on Nasdaq

The Initial Listing Decisions of Firms that Go Public

We analyze the initial listing decisions of IPOs that qualify for New York Stock Exchange listing. We find that IPOs are more likely to list on the exchange where their industry peers are listed. Further, reverse LBOs and carveouts are more likely to choose the NYSE if the firm or their parent was previously NYSE-listed. Consistent with avoidance of delisting costs, we find that smaller, riskier firms tend to list on Nasdaq. Although direct issue costs are higher on the NYSE than on Nasdaq, total issue costs do not differ across exchanges and are unlikely to affect the listing decision.

Highly leveraged transactions and managerial discretion over investment policy: An overview

These discussion comments place the evidence by Denis and Denis on leveraged recapitalizations in the broader context of highly leveraged transactions, including going-private transactions, management buyouts, and so-called reverse LBOs. The evidence indicates that highly levered companies that remain publicly-owned experience improvements in operating performance and reductions in capital expenditures following the leverage boost comparable to those of companies that have gone private. Despite increases in operating income, however, the obligations of the additional debt taken on are sufficient to preclude management from internally financing capital expenditures at previous levels. There is evidence consistent with the claim that this limitation benefits stockholders.

Efficiency and Organizational Structure: A Study of Reverse LBOs

ABSTRACTThis paper is a report on 72 firms which went public since 1983 but previously underwent a full or divisional LBO. Accounting measures of performance reveal significant improvements in profitability which resulted mainly from these firms' ability to reduce costs. Firms experience dramatic increases in leverage at the LBO, but the leverage ratios are gradually reduced. The evidence is consistent with the hypothesis that the change in the governance structure of these firms towards more concentrated residual claims created a new organizational structure which is more efficient than its predecessor.

Efficiency and Organizational Structure: A Study of Reverse LBOs

Efficiency and Organizational Structure: A Study of Reverse LBOs