Management buyouts of public corporations: An empirical analysis

Leveraged buyouts come in a variety of forms, but can be distinguished by the characteristics of the entity acquired. On this basis, two categories are clear. There are: (1) leveraged buyouts of a firm, and (2) leveraged buyouts of a division or subsidiary of a firm. Further, we may distinguish within the first category between firms that are public corporations and those that are private companies. Of these different examples of leveraged buyouts, management buyouts of public corporations have evoked the most public concern. For the purposes of this study, a management buyout is the purchase of a corporation by a group involving some members of management, which includes the board of directors and the corporation's top operating officers.; The primary purpose of this study is to examine management buyouts of public corporations in order to distinguish between different hypotheses about their nature and intent. After surveying both the theoretical and empirical literatures on management buyouts, leveraged buyouts, and going private transactions, four hypotheses are identified for further study. These hypotheses are: (1) a transactions cost argument, (2) a tax argument, (3) a free cash flow argument, and (4) a defective managerial compensation contract argument. Following this identification, we set out the theory behind an alternative explanation for these transactions, which we call the risky arbitrage hypothesis. This hypothesis basically posits that when there is a divergence between the firm's going concern value and its break up or restructure value, then there is a basis for arbitrage, for which managers will have a comparative advantage in execution.; In order to test these hypotheses we first compare measurements on selected characteristics of firms which subsequently go private through a management buyout with similar measures for another sample of firms which remain public concerns. The selected characteristics, their signs, and significance is determined by the different hypotheses for analysis. A logistic model of the probability of going private through a management buyout provides the statistical framework for testing the signs and significance of the selected characteristics. The results of this analysis provide strong support for the risky arbitrage hypothesis, and little or no support for the other hypotheses.; To supplement this analysis, we examine the post buyout actions of firms which go private through a management buyout. The analysis of data on their post-buyout actions, for our sample of 102 MBO firms, again supports the risky arbitrage hypothesis. Consequently, this study concludes that the evidence examined is consistent with the risky arbitrage hypothesis, and not supportive of the alternatives.