Management buyouts, financial leverage, and shareholders' wealth

Purpose. The purpose of this dissertation is to investigate the reasons for management buyouts and their impact on shareholder's wealth. By analyzing the behavior of stock returns during management buyouts, it is possible to identify the reasons for the buyouts and the sources of the associated changes in the wealth of shareholders.; Importance of the topic. A major challenge confronting the Theory of Corporate Finance has been to provide an explanation of the observed reluctance of firms to fully exploit the apparent tax advantage of debt. Recently, progress has been possible by explicitly considering the divergence of the interests of the firm's insiders and its other security holders, particularly under asymmetric information. Insiders' tendency to pursue self-interest, combined with the inability of outsiders to observe precisely the level and outcome of managerial effort, creates a moral hazard problem and leads to compromises from the value-maximization prescription.; By internalizing the conflict of interests between insiders and outside capital suppliers, the management buyout successfully resolves the moral hazard problem, and results in improved managerial incentives and higher debt utilization. The manner of the sharing of the capitalized value of these benefits between the two groups depends on the insiders' degree of divestment in the buyout, and may also be affected by the presence of competing takeover bids and legal challenges to the proposed transaction.; Methodology. The overall impact of the buyout on shareholders' wealth is estimated using "event study" methodology, by measuring the "excess returns" earned by shareholders during the buyout. Linear regression analysis is used to estimate cross-sectionally the differential impact due to debt financing, improvement in managerial incentives, and the degree of insiders' divestment. Also, the possible effects of shareholder litigation and competing takeover bids on excess returns are tested for.; Results. Positive association between the excess returns and the three effects hypothesized above is found to be present for the group of buyouts where there was outside investor participation. Whereas the existence of shareholder litigation is found to be negatively associated with the excess returns, the presence of competing takeover bids appears to have a positive influence.