Target CEO Retention in Acquisitions Involving Private Equity Acquirers

The following post comes to us from Leonce Bargeron, Frederik Schlingemann, and Chad Zutter, all of the Finance Group at University of Pittsburgh, and René Stulz, Professor of Finance at Ohio State University.

In the paper, Does Target CEO Retention in Acquisitions Involving Private Equity Acquirers Harm Target Shareholders?, which was recently made publicly available on SSRN, we examine whether target shareholders are affected adversely when the target CEO is retained by the acquirer and if the effect differs when the acquisition involves a private equity firm. We find that private equity acquirers are more likely to retain target CEOs, and, given an acquisition is made by a private equity firm, target shareholders receive a higher premium when the CEO is retained. The difference in premium is economically large as it corresponds to 10% to 23% of pre-acquisition firm value.

The reason for this higher premium is that the CEOs retained by private equity acquirers appear to be CEOs who have performed better and hence can add more value to the firm that results from the acquisition. Further, a CEO who is retained cannot compete with her former firm and we show that the premium paid if a CEO is not retained falls with the ease with which that CEO can compete with her former firm. The fact that better CEOs are more likely to be retained and that targets receive higher premiums when the CEO is retained is inconsistent with the view that the target CEO conflict of interest leads to inefficient retention of CEOs in exchange of lower premiums.

Because premiums paid by public firms are higher than premiums paid by private equity firms, the conflict of interest of the CEO could lead to an outcome where a firm is acquired by a private equity firm for a lower premium instead of being acquired by a public firm. We investigate this possibility. Such an investigation is intrinsically limited. It could be that a firm acquired by a private equity firm will never be acquired by a public firm due to unobservable characteristics. However, when we restrict the analysis to observable characteristics, we find that the firms acquired by public firms that are most comparable to the firms acquired by private equity firms with CEO retention do not receive a significantly different premium when the premium is measured over the three days surrounding the acquisition announcement or when the premium is measured as the Fama-French size and book-to-market portfolio adjusted buy-and-hold return from 42 trading days prior to the announcement of the winning bid to the completion date.

If private equity firms pay too little when the CEO is retained, we would also expect to see more competition for their acquisition attempts. Yet, we fail to find evidence that these acquisitions are associated with more competition or evidence that they are more likely to have deal characteristics that restrict competition. Finally, we investigate whether there is any evidence that CEOs who are retained in private equity acquisitions manipulate earnings to decrease the acquisition price, but find no such evidence.

Taken together, therefore, the evidence presented does not support the hypothesis that the CEO conflict of interest plays an important role in acquisitions by private equity firms, but instead shows that CEO retention in such acquisitions is valuable for target shareholders.

The full paper is available for download here.

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