EXAM: CRG EVIDENCE EXAM STACK Flashcards
For BOD Characteristics, State the evidences for the main points
1) Size of board: (Coles et. al. 2008) - “’simple’ firms experience a decrease in performance with larger boards, while ‘complex’ firms show an increase.”
2) Independence: (Pearce and Zahra 1991) - “The more NEDs who are Independent then it leads to higher performance.”
3) Diversity: (Guest, 2019) - No evidence of a relationship between ethnic diversity and performance.
4) Female directors: (Post and Byron 2015) - Female board representation is positively associated with accounting returns but has no impact on stock market performance.
For LBO Governance structure + Impact, state the evidences needed for main points
1) Leveraged debt (debt bonding): (Denis 1994, Phan and Hill 1995) - No evidence debt has an impact on post-LBO performance
2) Management stake (Motivation to generate profit): (Phan and Hill, 1995; Thompson et al., 1992; Nikoskelainen and Wright, 2007) - Evidence management equity has a positive effect on post-LBO performance
3) PE Firms are active investors (Cotters and Peck 2001) - Evidence monitoring and industry specialisation by PE firms has a positive impact on post-LBO performance
For LBO debate on its they provide value or just redistribute wealth, state the evidences needed for the main points
1) Higher debt = tax shield distributing wealth to buyout investors;
- Kaplan (1989) - tax benefits can represent up to 72% of premium paid to pre-buyout shareholders.
- Renneboog et al. (2007) - Connection between the tax shield associated with higher debt levels in LBOs and the payment of higher prices for target firms.
2) Job and wage cuts; Mixed evidence depending on country.
- Amess et al. (2014) found no significant effect on wages and jobs in UK firms following LBO.
- Davis et al. (2014) discovered that employment growth is slightly less than 1% lower in US firms subjected to LBOs.
- Antoni et al. (2019) contribute to this discussion by revealing that German firms experiencing LBOs may reduce jobs by 9% and median earnings by up to 2.8%.
3) Management buy-outs; conflicting evidence on if managers help decrease price paid for firm.
- (Mao and Renneboog, 2015) state that Managers have incentive to understate earnings – evidence to support this arugment.
- Smith (1990) and Lee (1992) state “if Management Buyout (MBO) bids accurately reflect the true value of a firm, a failed MBO attempt would persistently affect the firm’s value.” However, the absence of supporting evidence raises doubts about the reliability of MBO bids in consistently revealing a company’s true worth, casting uncertainty on their effectiveness as indicators of fair market value.
For PE Business model Q, state the evidences needed for the main points
Jensen (1989) - (LBOs) provide a solution to the free cash flow problem by encouraging efficient capital allocation.
- In mature industries, LBO governance structure is deemed superior to PLC’s,Jensen argues that this governance advantage will contribute to the enduring prominence of LBOs in certain sectors.
Rappaport (1990) - “inherently LBO governance structure is transitory”, High leverage characteristic of LBOs imposes ‘strategic inflexibility’, reduced “financial slack” resulting from high leverage diminishes a company’s resilience to negative shocks.
Kaplan (1991) supports Rappaport’s as LBOs are a form of ‘shock-therapy’
Reverse LBO performance - Cao and Lerner (2009) - “Stock performance of Reverse LBOs is as good or better than other IPOs”, “High leverage has no significant effect on performance”
For CEO pay, state the evidences needed for Optimal contracting v Managerial power
Optimal: Studies show ESOs result in strong pay-performance relationship
1) Main et al., (1996) found a 10% ↑ in shareholder wealth => 7.2% ↑ in CEO total pay package
2) Hanlon et el. (2003) found that $1 of ESO grant is associated with the generation $3.71 of operating income over the 5 years after the ESO grant
Managerial power:
1) Buck et al. (2003) finds that the inclusion of LTIPs weakens the link between a £1,000 increase in shareholder wealth and CEO pay from £1.81 to £1.55, challenging optimal contracting perspective. This weaker link implies that the executives may have negotiated compensation packages, especially through LTIPs, that insulate them from the full effects of shareholder wealth creation.
2) Fattorusso et al. (2007) find no link between bonus (short-term rewards) and shareholder return. . BUT, The study found no statistically significant link between transparency measures and the likelihood of receiving a bonus, which is contradicting.
For CEO pay, state the theory and prediction from theory for optimal contracting
Theory: Optimal contracting suggests its possible to structure pay packages that reduce the agency problem leading to an increase in shareholder value.
The compensation contracts create financial incentives that reduce moral hazard in a principal-agent relationship such as bonuses, executive share options, equity, long-term incentive plans.
These components are used to:
1) ATTRACT talented individuals to a post (PARTICIPATON CONSTRAINT),
2) MOTIVATE managers to make decisions and take actions that maximise shareholder value (Incentive compatibility constraint)
3) REWARD managers for maximising shareholder value.
Prediction: Predicts a strong pay-performance relationship i.e. to reduce the agency problem managers pay is sensitive to share value
For CEO pay, state the theory and prediction from theory for managerial power perspective
Theory: Managerial power perspective suggests executives are in a position to influence the pay they receive and the structure of the contract they receive, thus leading to remuneration that is in
1) EXCESS of that required to ATTRACT talented individuals to a post (PARTICIPATION CONSTRAINT),
2) EXCESS of that required to MOTIVATE managers (Incentive compatibility) and
3) WEAK related pay-performance relationship.
Prediction: Predicts a weak pay-performance relationship i.e. managers extract rents that have no sensitivity to share value as rents are any level of pay to managers above that required to maximise shareholder value.
For BOD characteristics, state the theory and prediction for Size of the board
Theory: The SIZE of a company’s board of directors plays a pivotal role in influencing its financial performance. According to governance theory, a larger board facilitates enhanced monitoring and advice, incorporating diverse perspectives and specialized knowledge to inform strategic decisions.
Prediction: This is predicted to result in improved overall performance.
For BOD characteristics, state the theory and prediction for Independence of the board
Theory: INDEPENDENT DIRECTORS provide an independent view of a company’s performance/management and they are not biased towards the firm as they don’t rely on the firm for their main source of income. This independence leads to better scrutiny.
Prediction: The more independent directors on the board the better the firm performance.
For BOD characteristics, state the theory and prediction for diversity and female directors of the board
Theory: DIVERSITY within a board, including the inclusion of female directors, is theorized to be beneficial in overcoming groupthink during crucial discussions about the firm’s direction. groupthink refers to a phenomenon where the members of the board prioritize consensus and conformity over critical thinking and independent judgment. This can hinder effective decision-making, as dissenting opinions or alternative viewpoints may be suppressed in favor of maintaining unanimity.
However, it’s acknowledged that this increased diversity might lead to reduced cohesiveness among board members.
Prediction: While the theory suggests that a diverse board could enhance discussions, there is currently no clear evidence highlighting a direct impact on firm performance, either positive or negative. The anticipation is that the presence of diverse perspectives may not significantly alter performance outcomes.
For LBO Governance structure debate, state the theory and prediction from the theory for debt
Theory: Leveraged debt MEANS A Fixed interest obligation which reduces agency costs of FCF. This Debt enables managers to bond their promise to pay out future cash flow cf. equity. The extra FCF used to service debt, not negative NPV investments that were previously being done under previous manager. Thus, an Incentive to generate cash to service debt and meet obligations.
Prediction : Agency theory predicts post-LBO improvement in firm performance
For LBO Governance structure debate, state the theory and prediction from the theory for management stake
Theory: Management stake in the company. LBO reunifies the management and ownership functions that wasn’t there as it was PLC and managers before. Going forward, Management more likely to make decisions that increase firm value and FCF not used on unprofitable projects e.g. over-diversification. Thus, an incentive to not waste cash and refocus firms (Motivation to generate profit).
Prediction: Agency theory predicts post-LBO improvement in firm performance
For LBO Governance structure debate, state the theory and prediction from the theory for PE firms are active investors
Theory: PE firms are active investors and hold remaining equity not held by management. There is the Financial incentives to actively monitor senior management performance and strategic decisions more closely as PE firm has BoD representation, often Chair, facilitates: (i) scrutiny and (ii) counsel on strategic decisions. Another requirement is that PE firms require regular detailed reports (Thus financially motivated to scrutinise senior mgmt and decision making)
Prediction: Agency theory predicts post-LBO improvement in firm performance
For LBO Value or redistributing, state the theory and prediction for tax shield due to leverage (transfer from taxpayers)
Theory: Through leveraged buyouts (LBOs), firms intentionally increase their debt levels to enhance the value of these tax shields, providing buyout investors with a financial advantage.
Prediction: the prediction is that tax benefits, specifically those arising from the amplified tax shields in LBOs, will play a crucial role in the financial dynamics. This is expected to result in a substantial portion of the premium paid to pre-buyout shareholders being accounted for by tax advantages.
For LBO Value or redistributing, state the theory and prediction for Reduction in jobs and wages (a transfer from employees)
Theory: The theoretical underpinning of the argument regarding job and wage cuts in leveraged buyouts (LBOs) suggests that investors may benefit from cost-cutting measures, including workforce reductions. Critics contend that LBOs provide a financial incentive for investors to implement such measures, aiming to enhance the profitability of the acquired firms.
Prediction: Firm performance rises due to cost efficiencies and increased profitability.
