Consequences of PE & LBO's

Question 1

What are the theoretical predictions from an agency perspective of PE and LBO consequences to a PLC Firm?

Answer 1

• Agency perspective predicts that under-performing firms are targeted for an LBO
• Agency perspective predicts that the LBO governance structure leads to an improvement in firm performance
• Agency perspective predicts divestment in over-diversified firms in an LBO

Question 2

Whats the evidence concerning LBO performance?

(Pre-LBO, Post-LBO, and Operating Performance)

Answer 2

Pre-LBO: Harris et al. (2005) find evidence of lower performance pre-LBO – consistent with agency theory

Post-LBO: Renneboog et al (2007) - Pre-buyout shareholders receive premium of 40%, Share price increases by 30% on announcement of an LBO

Operating Performance: Amess (2003) – efficiency is 7%, 7.5%, 4% and 7% in first four years after a MBO.

Question 3

Examine the relationship between LBOs and divestment

Answer 3

Relationship is consistent with LBO governance structure reducing agency problem and the post-LBO firm undoing value destroying diversification.

Question 4

What is the evidence of LBO features being related/un-related to post-LBO performance?

(in terms of Management equity, debt and Active PE investing)

Answer 4

Management Equity: Positive effect on post-LBO performance (Phan and Hill, 1995)

Debt: No evidence debt has an impact on post-LBO performance (Denis, 1994; Phan and Hill, 1995)

Active PE Investing: Positive evidence monitoring and industry specialisation by PE firms has a positive impact on post-LBO performance (Cotter and Peck, 2001)

Question 5

Examine the conflicting evidence from Jensen 1986 and Renneboog et al. 2007 concerning the relationship between free cash flow and post-LBO performance

Answer 5

Jensen 1986 argues that post-LBO performance gains can arise from free cash flow no longer being wasted because of improved corporate governance

Whereas:

Renneboog et al. (2007) find no relationship between shareholder wealth gains and the reduction of free cash flow post-LBO

Question 6

Explain some criticisms of LBOs and the sources of LBO gains with evidence: tax shield, managers exploiting inside information, transfers from employees

Answer 6

Tax shield: LBO increases debt, which increases value of tax shield.

(Renneboog et al. 2007) Tax shield associated with higher prices paid for target firms — pre-LBO owners benefit from selling at higher price due to future tax savings.

Inside info mgmt: Managers have incentive to understate earnings – evidence to support this argument (Mao and Renneboog, 2015) thus looks better post LBO for gains

Transfers employees: Critics argue LBO investors benefit from job and wage cuts, evidence on this is mixed. (Amess et al., 2014) argues no effect on wages and jobs in UK firms.

Question 7

Why is a Buy and Build strategy good for PE Firms?

& evidence why it results in higher equity

Answer 7

PE firm buys a portfolio firm that acts as a ‘platform’ for subsequent ‘add-on’ acquisitions that create value through economies of scale, economies of scope, synergies

(Hammer et al., 2022) Equity returns are higher when a B&B strategy is used compared to a stand-alone deal.