Do Investors Understand ‘Operational Engineering’ before Management Buyouts?
Julie Lei Zhu
Boston University - School of Management
Boston College - Finance Department; University of Pennsylvania - Wharton Financial Institutions Center; China Academy of Financial Research (CAFR)
Hong Kong University of Science & Technology (HKUST)
May 25, 2012
During the year prior to management buyout (MBOs) announcements, some target firms exhibit abnormally high discretionary expenses in selling, general and administration, abnormally low discretionary accruals, and realize losses from asset sales. Higher discretionary expenses and losses from asset sales are associated with lower pre-MBO abnormal stock returns, especially for firms with higher insider ownership, less institutional monitoring and higher information asymmetry. They are also associated with better post-MBO operating performance. None of these activities affects the likelihood of MBO deal completion, announcement period abnormal returns, or offer premium. These target firms do not show such abnormal activities in other years before the MBOs or after the MBOs. Our results suggest that outside investors and the market do not fully understand the earnings-reducing activities before MBOs, and such ‘operational engineering’ allows managers to acquire the targets “on the cheap” and to show better post-MBO performance.
Number of Pages in PDF File: 41
Keywords: Management buyout, leveraged buyout, accrual, real earnings management, stock return
JEL Classification: G34, G14, M41, M48working papers series
Date posted: March 17, 2012 ; Last revised: May 25, 2012
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