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Buy-to-Sell versus Buy-to-Keep: A Product Market Theory of Buyouts

Buy-to-Sell versus Buy-to-Keep: A Product Market Theory of Buyouts. Pehr-Johan Norbäck Lars Persson Joacim Tåg. Agenda. Introduction General Framework A Product Market Theory of Buyouts Takeaways. Introduction. Private Equity Buyouts (LBOs). Banks. Institutional Investors. Targets.

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Buy-to-Sell versus Buy-to-Keep: A Product Market Theory of Buyouts

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  1. Buy-to-Sell versus Buy-to-Keep:A Product Market Theory of Buyouts Pehr-Johan Norbäck Lars Persson Joacim Tåg

  2. Agenda • Introduction • General Framework • A Product Market Theory of Buyouts • Takeaways

  3. Introduction

  4. Private Equity Buyouts (LBOs) Banks Institutional Investors Targets Private Equity Funds 6-10 year Targets Private Equity Partners

  5. Advantages • ”Active” owners • Managerial ownership • Debt • Monitoring Solvemanagerial agency problems

  6. Question Why do not public firms do the same?

  7. Our Contribution

  8. Develop a new framework • When do buy-to-sell owners emerge in equilibrium? • How does buying to sell affect strategic investments?

  9. A Product Market Theory of Buyouts • Why are buyout firms more ”active” owners than public firms? • Is ”active” ownership a reason for their existance? • Empirical predictions on differences in behavior

  10. The General Framework

  11. Buying to Sell or Buying to Keep Stage 1: Acquistion auction Buy-to-keep Buy-to-sell Stage 2: Investment Stage 3: Exit Stage 4: Long run

  12. Difference in Investment Incentives • Stage 2: First order conditions • Equal investments only if

  13. Ownership Depends on Investment • Stage 1: Valuations • Rankings:

  14. Application:A Product Market Theory of Buyouts

  15. Overview • Public firms buy to keep (have assets) • Buyout firms buy to sell (trade-sale exit) • Strategic investment is managerial ownership => Restructuring effort • Debt, monitoring also works (”active”)

  16. Structure and Timing Stage 1: Acquistion auction Incumbent Buyout Stage 2: Compensation contract Restructuring intensity Stage 3: Exit auction Stage 4: Product market interaction

  17. Stage 4: Product Market Competition • Firms maximize: • Nash-Equilibrium : • Reduced form profits:

  18. Assumption 1 • Restructuring improves competitiveness:

  19. Structure and Timing Stage 1: Acquistion auction Incumbent Buyout Stage 2: Compensation contract Restructuring intensity Stage 3: Exit auction Stage 4: Product market interaction

  20. Stage 3: Exit (Trade Sale) • First price perfect information auction • Incumbent valuation: • General: Restructured firm is obtained by an incumbent at price

  21. Structure and Timing Stage 1: Acquistion auction Incumbent Buyout Stage 2: Compensation contract Restructuring intensity Stage 3: Exit auction Stage 4: Product market interaction

  22. Stage 2: Compensation contract • CARA preferences: • Linear contract: • Maximization

  23. Stage 2: Managerial Ownership • Participation: • Costs:

  24. Stage 2: Managerial Ownership • Incumbent: • Buyout:

  25. Stage 2: Managerial Ownership Marginal profit and marginal cost Managerial ownership

  26. Structure and Timing Stage 1: Acquistion auction Incumbent Buyout Stage 2: Compensation contract Restructuring intensity Stage 3: Exit auction Stage 4: Product market interaction

  27. Result 1: Buyout firms more ”active” • Buyout firms more ”active” because they buy to sell • Stronger incentive contracts: • More restructuring:

  28. Structure and Timing Stage 1: Acquistion auction Incumbent Buyout Stage 2: Compensation contract Restructuring intensity Stage 3: Exit auction Stage 4: Product market interaction

  29. Stage 1: Equilibrium Ownership • Valuations • Buyout • Incumbent • Rankings:

  30. Stage 1: Equilibrium Ownership • Ownership depends on the sign of

  31. Result 2: Being ”Active” not enough • Buyout firms need an advantage to emerge in equilibrium (preemption) • Lower restructuring costs; more experience • Tax shield of debt

  32. Marginal profit and marginal cost Managerial ownership Net acquisition profits Managerial ownership

  33. Empirical Predictions

  34. Buyout firms • give management more intense incentive contracts • Monitors more and takes on more debt • Does more restructuring => better operational improvements • Preference for exit through a trade-sale if IPO costs are large and restructuring not too expensive.

  35. Evidence • More intense contracts • More debt and board representation • Higher operational and financial performance • Leslie and Oyer (2008): debt and m.ownership returns to ”normal”

  36. Other Applications of the Framework

  37. Applications • Reputational concerns: • Protecting innovations: • Asymmetric information:

  38. Takeaways

  39. General Framework • New framework for analysis of buy-to-sell and buy-to-keep ownership • Maximizing sales price often not the same as maximizing long run value • Affects investments, which in turn affects equilibrium emergence.

  40. Product Market Theory of Buyouts • Buyout firms are more ”active” owners because they buy to sell. • Optimal managerial ownership, debt and monitoring higher than at public firms • Returns to “normal” post exit • Being ”active” is not enough to outbid incumbents for assets • Preemptive motive • Expertise or tax shield needed

  41. Thank you for your time!

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