CRG L7 - 2019

Corporate Restructuring
& Governance
BUSI 3101
Lecture 7
Dr. Young Un Kim
2016 CRRC International Talent Development Programme

Announcements
• Seminars start tomorrow (throughout next week)

• Attend your designated seminar time
You are required to:

– Read the article of Denis 1994 with various cases of
restructuring that is provided on Moodle under seminar 1.
– Prepare answers to the questions asked in the document
seminar 1 assignment on Moodle under seminar 1.
Copyright 2019 © Nottingham University Business School China. All Rights Reserved 2
Lecture 7:The results of buy-outs
• Revisit the Controversy
• Do buyouts improve performance of firms?
• How can we explain the improvements, what are
the sources of the gains?
– Equity vs. debt
– R&D Entrepreneurship
• PE fund returns
Copyright 2019 © Nottingham University Business School China. All Rights Reserved
Controversy
• “Sometimes, [PE firms] give the impression of

being little more than amoral asset-strippers
after a quick buck. Casino capitalists enjoying
huge personal windfalls from deals at the same
time as they gamble with other people’s futures.”
(Brendan Barber, General Secretary of TUC,
City University, 20 February 2007)
Controversy
• “PE firms are like vampires bleeding the

company dry and walking away enriched even
as the company succumbs.”
(Senator Elizabeth Warren calling for greater
federal regulation of the industry, October 2019)
Controversy
• “We’re in the business of creating strong, long-

term competitive businesses.” (Damon Buffini,
Permira, BBC Radio 4 Today Programme, 23
February 2007)
Buy-out Longevity - Competing Views
• Jensen
Buy-outs a new long-term form of organization
(stronger governance, debt disciplines managers)
• Rappaport
Limited scope, short-term form of organization (high
debt reduces flexibility; desire of investors to cash out;
absence of daily stock prices as objective measure of
corporate value)
• Kaplan/Wright et al.
Heterogeneous longevity (nature of buy-out, size of
buyout, divisional buyout or full firm buyout).
Entrepreneurship perspective
- Entrepreneurial finance
- Entrepreneurship/Long-term value creation

Entrepreneurial Finance
Non-core divisions/subsidiaries and private firms find it
difficult to get access to finance
• PE firms are able to ease access to finance in
financially constrained firms (Boucly et al., 2011;
Amess et al., 2015)
 Governance structure and PE firms financial expertise
reassures creditors
 PE firms provide connections to sources of finance
• Relaxing portfolio firms’ financial constraints allows
them to invest in profitable growth opportunities
Entrepreneurship (1)
Divestment of division/subsidiary parent
• Divisional structure cuts divisional managerial
incentives and rewards
 Power dynamics may determine investment decisions
rather than profitability, divisional managers running
profitable divisions might not get funds to invest –
reduces incentives to generate profit
 If division is a “cash cow”, no incentive to generate profit
because cash is invested in other division(s)
 New divisions that do not fit with parent company may
lack necessary investments
• Corporate refocusing of parent prompts divestment
Entrepreneurship (2)
• LBO replaces bureaucratic incentives with market-
based incentives
• Management and PE firm equity holdings create
entrepreneurial incentives for profitable business
development e.g. new product development and
better use of R&D expenditure
• PE firms provide managerial skills to help LBO
management pursue entrepreneurial opportunities
• Entrepreneurship perspective predicts post-LBO
growth
• Wright et al., (2009); Thompson and Wright (1995)
Sources of Gains: Entrepreneurship
Zahra (JBV, 1995)
• Examines changes in entrepreneurial actions after
buy-out
• 47 LBO firms where managers paid 25% of
purchase value
• Compares pre and post LBO commitment to
corporate entrepreneurship
• Compares pre and post LBO performance
(profitability and productivity)
• Examines link between changes in entrepreneurial
actions and performance
Zahra (JBV, 1995) contd.
Finds LBOs:
• Increase commitment to corporate
entrepreneurship
• Have greater emphasis on commercialization
• Intensify new venture efforts
• Don’t reduce R&D spending
• Performance higher than pre-LBO and industry
average
• Significant link between entrepreneurship and
performance
Performance effects
- Theoretical predictions
- Wealth effects
- Operating performance

Theoretical predictions
• Theory predicts that under-performing firms are

targeted for an LBO
• Theory predicts that the LBO governance
structure leads to an improvement in firm
performance, evidence supports this.
Market Performance
• Renneboog et al (2007)
 Pre-buyout shareholders receive premium of 40% -
main sources are undervaluation, tax shield, and
incentive realignment
 Share price increases by 30% on announcement of
an LBO
Operating performance
• Cressy (2007) – operating profitability of PE backed

buy-outs greater than comparable non-buyouts by
4.5% over first three years post-buyout
• Amess (2003) – efficiency is 7%, 7.5%, 4% and 7%
in first four years after a MBO
• Harris et al. (2005) – 90% improvement in
productivity in MBOs
• Most, if not all, evidence looks at short-term
performance (less than 5 years)
“there is a general consensus across different
methodologies, measures, and time periods
regarding a key stylized fact: LBOs [leveraged
buyouts] and especially MBOs [management
buyouts] enhance performance” (Cumming et al.,
2007, pg. 449)
Sources of performance gains
- Governance characteristics: management equity, debt and active monitoring by PE investors
- Tax shield
- Inside information
- Transfers from employees

Governance structure
Management equity
• How would Management equity impact firm
performance?
Debt
• How would Management equity impact firm
performance?
Active PE investors
• How would the private equity firm (general
partner) impact firm performance?
Management equity
• Remarries Ownership & Control
• Provides incentives to seek out value maximizing
opportunities
Debt
• Commitment to perform and to service debt
• Curtails ability to invest in wasteful projects
• Debt covenants restrict actions
Active PE investors
• Concentrated ownership increases incentive to take
action
• Requirements for regular detailed reports
• PE board representation
Management equity
• Management equity has the largest effect on post-LBO
performance (Phan and Hill, 1995; Thompson et al.,
1992; Nikoskelainen and Wright, 2007)
Debt
• Little evidence that debt has an impact on post-LBO
performance (Denis, 1994; Phan and Hill, 1995)
Active PE investors
• Evidence that active monitoring and industry
specialisation by PE firms has a positive impact on
performance (Cotter and Peck, 2001; Guo et al., 2011)
• PE firm experience might also have a positive
performance impact (Gottschalg and Wright, 2008)
Tax shield
• Interest is tax deductible

• US evidence that tax benefits account for up to
72% of premium paid to pre-buyout
shareholders in PTPs (Kaplan, 1989)
Inside information
• In MBOs management have a dual role:

negotiating the highest price for owners and
being members of management team wanting to
pay lowest price for firm
• Managers have incentive to understate earnings
and exploit inside information (DeAngelo, 1986,
Lee 1992)
Transfers from employees
• Critics argue that LBO investors benefit from job and

wage cuts
• US and UK evidence is mixed
• US firms loses 10% of jobs in 5 years post take-over
(Hall 2008)
• US evidence shows employment grows at a slower
rate than other firms (Lichtenberg and Siegel, 1990;
Davis et al., 2008)
• UK evidence LBOs have no effect on wages and
jobs (Amess et al., 2013)
Returns to PE fund investors

Returns to PE fund investors
• Firm-level evidence suggests LBO firms create

value (at least in short-term)
• Do limited partner investors receive high returns
as a consequence of this value creation?
Kaplan and Schoar (2005)
• PE funds outperform the S&P 500 index but net of
management fees, LPs (investors) earn 93% of what
could have been earned investing in the S&P 500
 PE firms add value above what has been paid to acquire a
firm, but LPs do not benefit from all of the gains
• Heterogeneity in fund performance
 High variation of PE funds compared to S&P 500 index
• Persistence in PE firms’ fund performance –
performance in one PE firm’s fund performance
predicts performance in subsequent funds
 Explains why LPs seek to invest in PE firms funds where the PE
firm has demonstrated good performance in previous funds
Summary
• LBOs create wealth and improve firm

performance
• Buy-outs can happen for various reasons (i.e.
efficiency gains and/or entrepreneurial gains)
• PE firms gain most and not all performance
gains appear to be transferred to LPs
Next Lecture
• Focus on Market for Corporate Control
• Read articles relevant for lectures 8
Key articles:
– Michael C. Jensen (1988): Takeovers: Their Causes and
Consequences
– O’Sullivan and Wong (2005): The Governance Role of
Takeovers, Chapter 8 in Keasey et al., Corporate
Governance
– Tuch and O’Sullivan (2007) The impact of acquisitions …
THANK YOU

CRG L7 - 2019

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Corporate Restructuring

Dr. Young Un Kim

2016 CRRC International Talent Development Programme

• Seminars start tomorrow (throughout next week)

You are required to:

• “Sometimes, [PE firms] give the impression of

• “PE firms are like vampires bleeding the

• “We’re in the business of creating strong, long-

2016 CRRC International Talent Development Programme

2016 CRRC International Talent Development Programme

• Theory predicts that under-performing firms are

• Cressy (2007) – operating profitability of PE backed

2016 CRRC International Talent Development Programme

• Interest is tax deductible

• In MBOs management have a dual role:

• Critics argue that LBO investors benefit from job and

2016 CRRC International Talent Development Programme

• Firm-level evidence suggests LBO firms create

• LBOs create wealth and improve firm

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