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Financial performance of leveraged buyouts: An empirical analysis

1989; Elsevier BV; Volume: 4; Issue: 4 Linguagem: Inglês

10.1016/0883-9026(89)90016-5

1873-2003

Ivan Bull,

Auditing, Earnings Management, Governance

This study compares management performance before and after leveraged buyouts of 25 sample companies. Average performance for the two years before a leveraged buyout is compared to average performance for the two years after a buyout. The year of the buyout is omitted from comparisons because it usually includes recognition of a number of atypical events which distort comparisons. Managers must acquire some equity ownership as part of the buyout, and a major restructuring must not occur in either the pre- or post-buyout periods. Seven accounting variables, adjusted in the pre-buyout periods to reflect values reflected in the post-buyout periods, are used to measure performance. Comparison of pre- and post-buy out performance are made directly for the same entity. Comparisons are also made of pre- and post-buyout performance in terms of the ratios of company performance to industry performance. Multivariate analyses of variance, using all seven variables, reflect change in both comparisons which is significant at the .001 level. Post-hoc tests are performed to attempt to identify the extent of change in the separate variables and to examine the significance of income tax savings. Financial performance after the buyouts is superior to performance before the buyouts. The evidence is convincing that management focus changes, apparently from minimizing variability in reported profits to maximizing cash flow. The improvement is greater than from income tax savings alone. Three groups of LBO participants are interviewed to gain insight into the forces behind the changes which are reflected in the financial data. Executives of institutional investors, LBO house principals and chief executive officers of LBO companies, all anticipate a higher return on investment in the post-buyout period and more efficient use of corporate assets. They tend to consider cashflow to be the primary measure of performance of LBO companies. The reason for the improvement in performance cannot be identified with certainty, but no explanation is more persuasive than the introduction of entrepreneurial management by the small group of new owner-managers. Interviewees provide anecdotal evidence that the utility functions of on-site managers and other investors converge on the task of debt reduction, indicating a reduction of agency costs. Absence of free cash flow in the post-buyout period also provides support for lesser agency costs. However, the introduction of entrepreneurial management is interpreted to include the exploitation of a wider set of opportunities to achieve wealth and position for owner-managers than from the reduction of agency costs alone. The findings are important for investors, future LBO players, and for makers of public policy. Efficiency improvements can reasonably be expected from similar future leveraged buyouts, improvement not dependent on income tax savings.