In a typical leveraged buyout, there are three components. The acquirers borrow a significant portion of a publicly traded firm's value (leverage), take a key role in the management of the firm (control) and often take it off public markets (going private). None of these three components is new to markets and there can clearly be good reasons for each of them. Starting with traditional corporate finance first principles, we examine the conditions that are necessary for each component to make sense. Using the aborted Harman LBO, where KKR and Goldman were lead players, as a case study, we argue that choosing the wrong target for a leveraged buyout is a recipe for disaster even for the most reputed players in the business. In other words, no amount of deal expertise can overcome poor financial fundamentals. In closing, we argue that the three components in an LBO are separable and that bundling them together as essential pieces of every deal is a mistake.
{"title":"The Anatomy of an LBO: Leverage, Control and Value","authors":"A. Damodaran","doi":"10.2139/ssrn.1162862","DOIUrl":"https://doi.org/10.2139/ssrn.1162862","url":null,"abstract":"In a typical leveraged buyout, there are three components. The acquirers borrow a significant portion of a publicly traded firm's value (leverage), take a key role in the management of the firm (control) and often take it off public markets (going private). None of these three components is new to markets and there can clearly be good reasons for each of them. Starting with traditional corporate finance first principles, we examine the conditions that are necessary for each component to make sense. Using the aborted Harman LBO, where KKR and Goldman were lead players, as a case study, we argue that choosing the wrong target for a leveraged buyout is a recipe for disaster even for the most reputed players in the business. In other words, no amount of deal expertise can overcome poor financial fundamentals. In closing, we argue that the three components in an LBO are separable and that bundling them together as essential pieces of every deal is a mistake.","PeriodicalId":127572,"journal":{"name":"ERPN: Leveraged Buyouts (Sub-Topic)","volume":"302 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2008-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122825203","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the effects of leveraged buyouts (LBOs) on the industry rivals of the firms that undertake the LBO. Specifically, we are interested in determining whether or not the rivals that remain public take steps to change their governance mechanisms to emulate the firms that go private. Specifically, we examine CEO compensation, and the compensation and composition of the board of directors. We document an increase in the number of options awarded to CEOs following LBO activity in an industry, and a decrease in annual bonuses and restricted stock grants as LBO activity slows down. Our results also indicate the likelihood of changing the CEO is positively correlated with LBO activity. We also demonstrate significant changes in the pay for directors and the structure of the board after LBOs occur in an industry. Overall, our examination yields results that indicate firms effectuate significant corporate governance changes following an LBO event in their industry.
{"title":"Governance Effects of LBO Events","authors":"J. Oxman, Yildiray Yildirim","doi":"10.2139/ssrn.1106706","DOIUrl":"https://doi.org/10.2139/ssrn.1106706","url":null,"abstract":"We examine the effects of leveraged buyouts (LBOs) on the industry rivals of the firms that undertake the LBO. Specifically, we are interested in determining whether or not the rivals that remain public take steps to change their governance mechanisms to emulate the firms that go private. Specifically, we examine CEO compensation, and the compensation and composition of the board of directors. We document an increase in the number of options awarded to CEOs following LBO activity in an industry, and a decrease in annual bonuses and restricted stock grants as LBO activity slows down. Our results also indicate the likelihood of changing the CEO is positively correlated with LBO activity. We also demonstrate significant changes in the pay for directors and the structure of the board after LBOs occur in an industry. Overall, our examination yields results that indicate firms effectuate significant corporate governance changes following an LBO event in their industry.","PeriodicalId":127572,"journal":{"name":"ERPN: Leveraged Buyouts (Sub-Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2008-02-11","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128650745","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The traditional law and finance focus on agency costs presumes, without acknowledgement, that the premise that diversified public shareholders are the cheapest risk-bearers is immutable. In this Essay, we raise the possibility that changes in the capital markets have called this premise into question, drawn into sharp relief by the recent private equity buying wave in which the size and range of public companies being taken private expanded significantly. In brief, we argue that private owners, in increasingly complete markets, can transfer risk in discrete slices to counterparties who, in turn, can manage or otherwise diversify away those risks they choose to forego, arguably becoming a lower cost substitute for traditional risk capital. If diversified shareholders are no longer the cheapest risk-bearers, then the associated agency costs may now be voluntary; and, if risk management can substitute for risk capital, without requiring a transfer of ownership, then why go public at all? Do more complete capital markets herald (once again) the eclipse of the public corporation? We offer some preliminary responses, suggesting that the line between public and private firms may begin to blur as the traditional balance between agency costs and the benefits of public ownership shifts towards a new equilibrium. For some, the benefits of public ownership may continue to outweigh the associated agency costs. For others, changes in risk transfer may implicate how a firm is (or should be) governed. The Essay then ends with a final question: If the opportunity to invest in common stock recedes, by what means will former investors in public equity be able to invest capital?
{"title":"Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets","authors":"R. Gilson, Charles K. Whitehead","doi":"10.7916/D80865C2","DOIUrl":"https://doi.org/10.7916/D80865C2","url":null,"abstract":"The traditional law and finance focus on agency costs presumes, without acknowledgement, that the premise that diversified public shareholders are the cheapest risk-bearers is immutable. In this Essay, we raise the possibility that changes in the capital markets have called this premise into question, drawn into sharp relief by the recent private equity buying wave in which the size and range of public companies being taken private expanded significantly. In brief, we argue that private owners, in increasingly complete markets, can transfer risk in discrete slices to counterparties who, in turn, can manage or otherwise diversify away those risks they choose to forego, arguably becoming a lower cost substitute for traditional risk capital. If diversified shareholders are no longer the cheapest risk-bearers, then the associated agency costs may now be voluntary; and, if risk management can substitute for risk capital, without requiring a transfer of ownership, then why go public at all? Do more complete capital markets herald (once again) the eclipse of the public corporation? We offer some preliminary responses, suggesting that the line between public and private firms may begin to blur as the traditional balance between agency costs and the benefits of public ownership shifts towards a new equilibrium. For some, the benefits of public ownership may continue to outweigh the associated agency costs. For others, changes in risk transfer may implicate how a firm is (or should be) governed. The Essay then ends with a final question: If the opportunity to invest in common stock recedes, by what means will former investors in public equity be able to invest capital?","PeriodicalId":127572,"journal":{"name":"ERPN: Leveraged Buyouts (Sub-Topic)","volume":"30 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-06-06","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126198170","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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