Essays on leveraged buyouts and distressed asset pricing
- Author(s): Ayash, Brian
- Advisor(s): Parlour, Christine
- et al.
This dissertation consists of three chapters that concern leveraged buyouts and the risk- return relationship of distressed stocks. The first chapter uses hand collected cash flow statements to present the origin, ownership and use of cash in leveraged buyouts of large publicly traded U.S. firms by private equity funds between 1980 and 2006. I find suggestive evidence that target firms exhibit inefficient investment in the form of empire building pre-acquisition. Once controlled by private equity funds, firms exhibit a significant decline in investment, sales and asset growth, and employment growth as debt is used to motivate managers and forces the release of excess free cash flows. I do not find evidence of value creation, as the profitability of the underlying assets does not increase under private equity control. There is evidence of an increase in cash flows from financial management expertise. This form of excess cash generation contributes to the funding of dividends but the majority of the funding is from asset sales and reduced investment prior to exit. Cash flow statements are also used to evaluate returns. I find that the IRR generated by underlying assets is insufficient to cover the cost of financing debt, adversely affecting the IRR to equity holders.
The second chapter, co-authored with Harm Schu ̈tt, tests whether leveraged buyouts improve targets operating performance? We hand collect complete, comprehensive financial statements for a sample of 138 large public U.S. firms that were acquired by private equity funds in leveraged buyouts between 1980 and 2006, and we examine the operating performance of these companies. Because of our comparatively large dataset with comprehensive financial statements we can better scrutinize operating performance and the technical accounting issues associated with leveraged buyouts. We find that the acquired firms do not exhibit post-buyout improvements compared to industry peers. In addition to operations, we evaluate outcomes for the acquired firms. In an expanded sample of 531 large public to private leveraged buyouts we find that 109 (21%) subsequently declare bankruptcy or were restructured outside the bankruptcy court while held by private equity funds. Our results suggest that while private equity managers might be savvy investors, they are not better operators of the target companies.
The third chapter explores the breakdown in the risk-return relationship of financially distressed stocks. I model firms in financial distress using an endogenous default model and demonstrate that distressed firms have nonsymmetric return distributions and are systematically mispriced under the CAPM. I propose the use of a CRRA utility model to correct for the mispricing of positive skewness in the return distribution of distressed stocks. I create portfolios using four distress measures and compare the risk-return relationship under both models. I find that the anomalously low return delivered by portfolios of the most distressed stocks is driven by the inclusion of OTC traded stocks.