Leveraged Buyouts: An Overview of the Literature

Luc Renneboog is Professor of Corporate Finance and Cara Vansteenkiste is a PhD student at Tilburg University. This post is based on a recent post by Professor Renneboog and Ms. Vansteenkiste.

The public corporation is often believed to have important advantages over its private counterpart. A stock market listing enables firms to raise funds in public capital markets, increases the share liquidity for investors, allows founders and entrepreneurs to diversify their wealth, and the higher degree of visibility and media exposure of public firms can be an effective tool in the marketing of the company. However, the publicly quoted company with dispersed ownership may suffer from too high a degree of managerial discretion resulting from a lack of monitoring which may lead to ‘empire building’ at the detriment of shareholder value. One way of refocusing the firm on shareholder value creation is to restructure the firm by means of a leveraged buyout (LBO), in which an acquirer takes control of the firm in a public-to-private (PTP) transaction financed largely by funds borrowed against the target’s assets and/or cash flows.

Although a growing number of studies focus on non-Anglo-American countries, systematic research into the sources of wealth and post-buyout performance in going-private transactions for countries other than the US and the UK is still limited. After being aggressively promoted in the 1970s by Wall Street practitioners, LBOs grew dramatically in the US during the 1980s. Despite a drop in deals in the 1990s, the beginning of the 2000s saw a second wave of PTP transactions in the US, UK, and Continental Europe, fueled by cheap debt in the CDO markets. Despite vastly exceeding the 1980s LBO wave in value terms, it came to a halt with the demise of the securitized debt markets at the end of 2007.

There are compelling reasons why the lessons drawn from US LBO research cannot entirely be extrapolated to UK and Continental European PTP transactions. The US, the UK, and Continental Europe differ in terms of the nature and extent of debt financing, the development of public capital markets, tax incentives, and the prevalence of hostile deals. Such differences in corporate governance regulation and the subtle idiosyncrasies in financial practices and culture on either side of the Atlantic influence the sources of wealth creation through going-private transactions and reduce the generalizability of US-based results to the UK/Continental European situation. This implies that there is a strong need for systematic further multi-country research into the second leveraged buyout wave.

In our paper Leveraged Buyouts: An Overview of the Literature, we aim to facilitate the development of a new research agenda by analyzing the motives to take public firms private and by providing a structured overview of the empirical research performed in this area. We first develop the theoretical framework for the potential sources of value creation from going private. We then review and summarize how these theories have been empirically verified in the four different strands of literature in LBO research. These strands of literature are categorized by phase in the LBO transaction: Intent (of a buyout), Impact (of the LBO on the various stakeholders), Process (of restructuring after the leveraged buyout) and Duration (of retaining the private status).

While the critics of going-private transactions have continuously emphasized tax advantages and the expropriation of non-equity stakeholders as the main sources of wealth gains from going private, systematic research on PTP transactions does not agree. Other potential sources of wealth gains are stronger incentive alignment with a focus on performance and value, the reduction in wasting corporate resources, and improved monitoring capabilities embedded in the governance structure of an LBO. In addition, going private eliminates the costs associated with maintaining a stock market listing, but may also be motivated by a defensive strategy against hostile takeovers.

We also investigate whether the post-transaction value creation as well as the duration of private status can be explained by the above mentioned potential value drivers. We conclude that the 1980s LBO wave triggered considerable operational improvements, driven by the organizational structure of the leveraged buyout and supporting the role of incentive realignment in the post-buyout value creating processes. Evidence from the most recent LBO wave documents only limited performance improvements for US LBOs, but there is however some evidence that Continental European LBOs do show significant increases in operating performance post-buyout.

We answer the questions whether or not PTP transactions lead to superior organization forms compared to public firms, and whether going private is a shock therapy to restructure firms. Some firms seem to use the organizational form of a going-private transaction as a temporary shock to enable them to restructure efficiently, while others regard the LBO as a sustainable superior organizational form. The decision to organize a reversed LBO or a secondary initial public offering depends both on firm-specific characteristics and environmental factors. However, privately owned holding periods in the second LBO boom increased relative to the 1980s wave, providing support for the sustainable organization form theory of private ownership.

Finally, we document the trends and drivers of global LBO activity in the 1980s, 1990s, and subsequent decades, and provide suggestions for further research. Future research could focus on the wealth effects of LBOs for stakeholders such as bondholders, suppliers, or employees, preferably in multi-country setting that takes into account cross-country differences in governance and labour regulations. It should also address the duration and the determinants of the private status of formerly public firm, as country-specific regulations may considerably affect the duration of LBO firms’ private status. The process of the realization of wealth creation once the firm has been taken private should also attract research interest, as little is known about that LBO stage in particular, apart from the fact that working capital management can create much additional value. There is also little non-US research on earnings manipulation in firms prior to a leveraged buyout although the incentives to manage upwards or downwards may differ between MBOs and IBOs or between firms with various levels of financial constraints. Lastly, most of our knowledge about LBOs is confined to public-to-private but more information is available for private-to-private transactions, which calls for additional research.

The full paper is available for download here.

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