Horse Picker or Right Jockey? An Examination of Private Equity Value Creation Through the Lens of Withdrawn Leveraged Buyouts
Posted: 18 Dec 2014
Date Written: May 1, 2014
This paper examines the consequences of leveraged buyout (LBO) transactions through the lens of subsequently withdrawn transactions. Using the reason for LBO withdrawal and the unfavorable credit market movements during the period when the deal is in play to address the endogenous withdrawal decision, I create a sample of LBOs withdrawn for reasons not related to target firm fundamentals. This paper documents the following facts. First, target firms of failed LBO transactions experience upward revaluation by the stock market. Such results are stronger for target firms with more information asymmetry problems. The evidence in my paper indicates that private equity investors are able to identify undervalued firms in the stock market. Second, I document improvements in operating performance of firms after LBO transactions compared to target firms that fail to go through the LBO process. Third, private equity investors adjust the capital structure of target firms to exploit the tax benefit of interest deductions. Fourth, private equity investors also tend to reshuffle the management of target firms shortly after the LBO transactions. Overall, the evidence suggests that private equity creates value by exploiting the undervaluation of target firms, and also by improving their operational performance and financial structure.
Keywords: LBO, Private equity, Undervaluation
JEL Classification: G24, G30, G31, G32, G34
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