buy-to-sell versus buy-to-keep: a product market theory of buyouts pehr-johan norbäck lars persson...
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Buy-to-Sell versus Buy-to-Keep:A Product Market Theory of Buyouts
Pehr-Johan NorbäckLars PerssonJoacim Tåg
Agenda
• Introduction
• General Framework
• A Product Market Theory of Buyouts
• Takeaways
Introduction
Private Equity Buyouts (LBOs)
Institutional Investors Banks
Targets
Private Equity Funds6-10 year
Targets
Private Equity Partners
Advantages
• ”Active” owners– Managerial ownership– Debt– Monitoring
Solve managerial agency problems
Question
Why do not public firms do the same?
Our Contribution
Develop a new framework
• When do buy-to-sell owners emerge in equilibrium?
• How does buying to sell affect strategic investments?
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
The General Framework
Buying to Sell or Buying to Keep
Stage 1: Acquistion auction
Stage 2: Investment
Stage 3: Exit
Stage 4: Long run
Buy-to-sellBuy-to-keep
k s
s s
k k
k s l
Difference in Investment Incentives
• Stage 2: First order conditions
• Equal investments only if
s k
k k k and
s s s.
#
#
Ownership Depends on Investment
• Stage 1: Valuations
• Rankings: Inequality Definition Winner Winning bid
I1 vkk vks vs k vkk
I2 vkk vs vks k or s vkk or vs
I3 vks vkk vs k vkk
I4 vks vs vkk k vs
I5 vs vkk vks s vs
I6 vs vks vkk s vs
vs s , vkk k and vks k , s
Application:A Product Market Theory of Buyouts
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”)
Structure and Timing
Stage 1: Acquistion auction
Stage 2: Compensation contract
Restructuring intensity
Stage 3: Exit auction
Stage 4: Product market interaction
BuyoutIncumbent l k, s
k , s
r k, r s
wkk r s
xAr l,xNAr l
k s
RAr k,RNAr k
RAr s,RNAr s
Stage 4: Product Market Competition
• Firms maximize:
• Nash-Equilibrium :
• Reduced form profits:
ix i,x i, r, z
i x i
x i ,x i ; r, z 0
RAr AxA r,
n 1
xNA r, . . . . ,xNA
r, r, and
RNAr NAxNA r,
n 2
xNA r, . . . . ,xNA
r,xA r, r.
#
#
Assumption 1
• Restructuring improves competitiveness:
dRArdr
0 anddRNArdr
0
Structure and Timing
Stage 1: Acquistion auction
Stage 2: Compensation contract
Restructuring intensity
Stage 3: Exit auction
Stage 4: Product market interaction
BuyoutIncumbent l k, s
k , s
r k, r s
wkk r s
xAr l,xNAr l
k s
RAr k,RNAr k
RAr s,RNAr s
Stage 3: Exit (Trade Sale)
• First price perfect information auction
• Incumbent valuation:
• General:
Restructured firm is obtained by an incumbent at price wkk r RAr RNAr
wkkr RAr RNAr
kr RAr
sr RAr RNAr
Structure and Timing
Stage 1: Acquistion auction
Stage 2: Compensation contract
Restructuring intensity
Stage 3: Exit auction
Stage 4: Product market interaction
BuyoutIncumbent l k, s
k , s
r k, r s
wkk r s
xAr l,xNAr l
k s
RAr k,RNAr k
RAr s,RNAr s
Stage 2: Compensation contract
• CARA preferences:
• Linear contract:
• Maximization
uw, r e wb, Cr
wb, b RAr F
r arg maxrEuw, r arg maxrb RAr F Cr
dRAdr
Cr dr
d RA,r
RA,rr
C 0
Stage 2: Managerial Ownership
• Participation:
• Costs:
wb, Cr w
lr r F w Cr
Stage 2: Managerial Ownership
• Incumbent:
• Buyout:
k arg max sr r
s arg max kr r
sr k
r dwkk r RAr
d
dRNAr dr
r d 0.
#
#
Stage 2: Managerial Ownership
0
Marginal profit and marginal cost
s Managerial ownership k
d r d
sr
dRAr dr
dRNAr dr
r d
k r
dRAr dr
r d
Structure and Timing
Stage 1: Acquistion auction
Stage 2: Compensation contract
Restructuring intensity
Stage 3: Exit auction
Stage 4: Product market interaction
BuyoutIncumbent l k, s
k , s
r k, r s
wkk r s
xAr l,xNAr l
k s
RAr k,RNAr k
RAr s,RNAr s
Result 1: Buyout firms more ”active”
• Buyout firms more ”active” because they buy to sell
• Stronger incentive contracts:
• More restructuring: r s r k
s k
Structure and Timing
Stage 1: Acquistion auction
Stage 2: Compensation contract
Restructuring intensity
Stage 3: Exit auction
Stage 4: Product market interaction
BuyoutIncumbent l k, s
k , s
r k, r s
wkk r s
xAr l,xNAr l
k s
RAr k,RNAr k
RAr s,RNAr s
Stage 1: Equilibrium Ownership
• Valuations– Buyout
– Incumbent
• Rankings:
vs s wkk r s r s
vkk k RAr k r k RNAr k
vks k , s RAr k r k RNAr s
vks vkkvs vkk
vs vks vkkor vks vs vkk
Stage 1: Equilibrium Ownership
• Ownership depends on the sign of
Inequality Definition Winner Winning bid
I1 vkk vks vs k vkk
I2 vkk vs vks k or s vkk or vs
I3 vks vkk vs k vkk
I4 vks vs vkk k vs
I5 vs vkk vks s vs
I6 vs vks vkk s vs
vs vks
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
vs vks wkk r s r s RAr k r k RNAr s RAr s r s RAr k r k .
#
#
Since s k , vs vks 0 always hold
0
Marginal profit and marginal cost
s
Managerial ownership
k
d r d
sr
dRAr dr
dRNAr dr
r d
k r
dRAr dr
r d
Net acquisition profits
0 Managerial ownership
RAr r
RNAr
vsvks
vks vs 0
vks RAr k r k RNAr s vs RAr s RNAr s r s
Empirical Predictions
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.
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”
Other Applications of the Framework
Applications
• Reputational concerns:
• Protecting innovations:
• Asymmetric information:
s k
s T k
s T k
Takeaways
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.
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
Thank you for your time!