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The evolution of capital structure and operating performance after LBOs: Evidence from US tax r eturns. Cohn, Mills, and Towery UBC Winter Conference, 2011. Motivation. Difficult to study what happens after firms go private—No longer file financial statements.
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The evolution of capital structure and operating performance after LBOs:Evidence from US tax returns Cohn, Mills, and Towery UBC Winter Conference, 2011
Motivation • Difficult to study what happens after firms go private—No longer file financial statements. • Existing evidence largely based on: • Firms with public debt outstanding. • Firms that exit (provide some backward looking data). • Firms do have to file tax returns! • Unique access to tax returns allows for a more complete view.
Questions addressed • What are the real and financial effects of LBOs? • Real Effects: • Do better incentives provided by concentrated ownership and disciplining effects of debt lead to better operating performance? • Financial Effects: • How does leverage evolve after the LBO • Temporary versus permanent effects on capital structure. • Tax implications.
What should one expect? • Practitioners talk about three sources of gains in LBOs. • Deleveraging. • Multiples expansion. • Operating Improvements. • Generally target >20% IRR to LP’s.
Comments • Paper would benefit from some structured hypotheses. • Jensen’s Free Cash Flow. • Decrease in investment and increase in profitability. • Underleverage. • Permanent increase in leverage. • Debt used as a transaction mechanism. • Transitory increase in leverage.
Comments • Need for some better comparisons to existing studies. • Mainly regarding how the tax data compares to Gaap financials. • Would be useful to compare your measures versus the gaap data pre-LBO and then during the LBO for the sample of public debt users. • EBIT versus EBIAT. • I think you actually report earnings before interest after tax.
Incentives and Performance Improvements (Oyer and Leslie) • Difficult to observe counterfactual. • Significant Heterogeneity.
Leverage changes • If this is an optimal capital structure why can’t public firms replicate this? • If the tax benefits are so large??? • What is special about the LBO structure to support so much debt? • Debt overhang? • Ability of sponsors to minimize risk/reduce bankruptcy costs? • Private versus public? • Reduce leverage again after an IPO.
Oyer and Leslie Increase in leverage is not permanent.
Comments • This does not look like Jensen’s free-cash flow hypothesis. • Higher incentives and debt curtail wasteful spending by managers and focus attention on cash flow generation. • No substantial operating improvements. • Significant asset growth. • Financed largely by debt. • Why does interest coverage hardly change despite increased debt?
Conclusions • Observe LBOs throughout the lifecycle. • How does the data compare to Compustat? • More direct tests of hypotheses. • Heterogeneity in LBOs. • Underleveraged prior to LBO? • Free cash flow problems? • Overinvestment?