Target bankruptcy risk and its impact on going-private buyout performance and exit

Research Question/Issue: What is the impact of bankruptcy risk on whether listed corporations are likely to be bought out by private equity firms and on the subsequent exit, including bankruptcy, of private equity backed public to private buy-outs? Research Findings/Insights: Using a sample of 246 UK companies that went from public to private (P2P) company status from 1997 to 2005, we find that going private companies have significantly higher default probability. Private equity firms sponsoring P2P deals acquire firms with higher risk of bankruptcy than non-acquired firms that remain public. We find evidence that high receivership risk at going private increases the chance that the target will end up in receivership, but post-P2P bankruptcy likelihood is less when the P2P is a management buyout rather than any other form of buyout. Independent boards of pre-P2P targets promote P2P deals and reduce the chances of bankruptcy after the buyout, suggesting a good corporate governance structure makes a positive contribution to bankruptcy avoidance after going private transactions. Theoretical/Academic Implications: Our finding that P2P deals involve targets with a higher risk of bankruptcy adds to theoretical insights about private equity as, in contrast to previous research, it suggests that PE firms are not deterred by the risk of financial distress but consider it a value creating opportunity. Our use of the option pricing framework represents a first and novel attempt at measuring bankruptcy risk and its impact on the ability of private equity firms to achieve effective turnaround. We find a link between better governance of the target pre-P2P and lower bankruptcy risk since where the PE investor inherits a strong governance structure, manifested in independent boards, chances of subsequent bankruptcy are reduced. Similarly, where the P2P acquisition is a management buyout, the probability of bankruptcy, post-P2P, is reduced, suggesting lower informational asymmetries and better alignment of interests between managerial and private equity investors. Although, due to the small number of receivership exits in our sample of P2P firms, the results are not as strong as we would like, a more extended analysis involving a larger sample over a longer period, in particular of firms exiting through bankruptcy is expected to produce stronger results. Our results provide a sufficient basis to warrant such further analysis

Determinants of Takeover Premium in Cash Offers: An Option Pricing Approach

In takeovers bidders offer a premium to target firm shareholders but the determinants of such premium are not clearly identified. Among the factors previously examined in the literature are prior target undervaluation, expected synergy and overpayment due to behavioural biases like hubris. In this paper we use an option pricing approach to decompose the observed takeover premia. We also test the implications of recent real options-based models of takeover premia and risk changes surrounding takeovers. We model the observed target stock price as a portfolio of unobserved stock price and a put option whose value depends on a number of target and deal characteristics that impinge on the probability of bid success. For a sample of over 200 UK cash takeover bids during 1990-2004, we estimate the put value using the Black-Scholes option pricing model and find that target firm revaluation accounts for a substantial part of the observed takeover premium and the put value accounts for a smaller, but still significant, proportion. The latter is higher in hostile, failed and longer bids. The put option value is also significantly correlated with the relative riskiness of bidders and targets, and synergy as predicted by Lambrecht (2004) . Movements in betas in the run up to takeover announcements and in the post-announcement period are consistent with the real options-based predictions of Hackbarth and Morellec (2008) . This study contributes to a better understanding of the true determinants of takeover premium and demonstrates the usefulness of option pricing models and provides a preliminary test of real options models in understanding and measuring the impact of UK takeovers on firm risk and shareholder gains. Copyright (c) 2010 Blackwell Publishing Ltd.

Allocative efficiency of internal capital markets: evidence from equity carve-outs by diversified firms

We examine whether equity carve-outs (ECOs) lead to improvements in the functioning of the internal capital markets (ICM) of diversified firms. Divestitures, including spin-offs, sell-offs, and equity carve-outs, can be employed by firms to improve allocative efficiency. Equity carve-outs, unlike other forms of divestiture, leave the parent’s ICM largely intact but provide the opportunity to enhance internal and external corporate governance mechanisms that can improve the parent’s ICM. Using a US sample of 354 equity carve-outs completed between 1980 and 2013, we find that the allocative efficiency of parents is augmented significantly following transaction completion. This increase in allocative efficiency is driven by improvements in both the external and internal governance characteristics of parent companies, consistent with the expectation that motivates equity carve-outs