February 24th, 2020

Leverage buyouts- is a going private transaction. This is where the firm which was previously public
traded would now become a private firm—replaced with completely equity ownership.

With leverage buyout the composition of the new owners is typically members of incumbent
management—a specialized buyout firm and other outside investors.

The buyout firm- assumes enough equity ownership in order to control the firm and most of the
financing for the transaction—check and balance in the system. Reduce incidence and impact of
agency problems and associated agency cost

ADVANTAGES OF LBO’s - EE

1. Stronger monetary incentives for the firms managers compared to those of a publicly traded
organization- Compared to when the company was publicly owned
2. There is more active monitoring since the buyout firm has both the incentive and means of
intervention. The LBO is expected to provide most of the finance, provides the incentive for
the firm.  easy means of intervention.
3. Most of the transaction are financed through debt- so high leverage forces management and
the partners to utilize cost reduction strategies and Improve efficiency
4. The available evidence indicates three things: EV
- Similar to takeovers, leverage buyouts usually purchase the equity of old shareholders at
a premium indicating the ability to turn around the firm and increase profits
- LBO’s which subsequently went public, increase their profits
- The way In which profits are increased was related to lower agency costs
- Many LBO’s are targeted at highly diversified firms which disposed of many of their
noncore divisions shortly after the transaction ( if the firm becomes smaller after the
buyout – that allows for better management and governance of the firm; if agency
problems are related to size and diversified nature of the firm and after the transaction
the agency problems are suppose to be addressed)

Limitations:

1. Heavy oversight from investors might cause managers to be cautious with regards to
investment choices ( consistent with critics of restructuring transactions involving
LBO’s who contend that management practices what is called short termism.
(Where the focus in on boosting current earnings )
2. They provide a disadvantage to the tax authorities (adv to the firm) Interest is tax-
deductible
5. Financial structure – the company’s structure of debt- debt is often considered as a
disciplinary device  especially when the maturity is relatively short.
- The payment of debt honoring financial obligations reduces the availability of Free cash
flow within the company ( it reduces the ability of the managers to use it in ways that
benefit them at the expense of the shareholders)
- Debt incentivizes the companies executives
(Typically a firm would like to establish itself as a good customer to a financial
institution- so they can help with its financing going forward [ ensure best efforts to
meet financial obligations)
 - Because of the tightly drafted agreements between the provider of finance and the firm,
when firms experience some financial distress, there is a transfer of control rights from
the management to the lender. [ provider of finance can enforce key elements of a debt
covenants ] [ they can even be extreme and throw the firm into bankruptcy]

Limitation of debt
- Firms may be prevented from undertaking good investment projects because debt
covenants keep them from raising additional funds (the debt over hang might be an
effective deter to new financing and investment

REFERNCE: ??

Comparative corporate governance systems

Lit presents 2 systems.

Anglo – American Market based system Vs the relationship based system

1. Anglo -American Market based system-

1. shareholding structure that is widely defused—widely dispersed shareholders
2. A fairly vigorous corporate control take over market
3. Emphasize Liquidity in the stock market ( it is easy for shareholders to dispose
shares- characterize for active trading- -makes it cheaper for companies to raise
capital by reducing the risk that investors will be unable to sell shares- easier for
firms to come to the market in search in new financing)
4. Shareholders generally leave mangers to their own devices – monitoring them
through their trading in the stock market- the behavior provide the approval ratings
for the behavior of management – reflected in share prices)- -the stock market
works as a disciplinary device.
5. Firms rely substantially on legal protection of shareholders – the system is
underpinned by fairly full disclosure of financial data to shareholders and by tough
insider trading laws banning agents from buying or selling on the basis of
confidential information
6. There is one tier board system

Japanese and German relationship based system of corporate governance

1. Large bank and intercorporate holdings

2. Banks play a jewel role with regard to its relationship with firms—they provide
debt financing and also take equity positions in companies (such banks are
called main banks – loans and reasonable ownership in the company)
- These main banks forge close long term relationship with managers by owning large
stakes in firms and holding them for a long time; Information about ,managers plans and
the direction of the companies is ascertain in the course of these relationships which are
sometimes consummated through seats on the companies board. ( where there is
concentration of ownership-these banks are large shareholders – better incentive to
provide effective governance – less reliance on disclosure of financial information and
more concentration of effective relationship) –
 3. Less on elaborate legal protection of investors and more on large investors and
banks

Which system is better?

- Can go for a hybrid *

- Benefits that main banks allow

Some researchers have argued that the faster economic growth enjoyed by Germany and Japan
since the 2nd world war—has been helped by their relationship based shareholding.

*they contend that the American corporate governance system with hostile take overs and leverage
restructuring imposes short horizons on the behavior of corporate management* - short-termism
and reduces the quantity and efficiency of investment thereby contributing to the American
competitiveness problem.-->

firms with a main bank relationship normally has longer term horizons for investments and undergo
financial distress with less economic distress and better access to financing.

In other words, firms with financial distress, banks not interested—firms with main banks—they
have the support.

**less pressure for short-term results**

Prof Miller (2003) – acknowledge that they two system of corporate governance means that they
are differences in corporate governance behavior (/??)

- Managers in the USA were more concerned with the current movement in stock prices

Since the Focus is on the shareholder value principle

- Japanese managers are less concerned about stock prices and more concerned about
market share
- American managers emphasis on shareholder returns is not a flaw in the US system of
corporate governance but rather one of its primary strengths
- One ought not to equate stock price with short-termism – focusing on current stock
prices is not short-termism. He argues that focusing on current stock prices is not short-
termism because stock prices reflect not just todays earnings but the earnings the
market expect in the future as well ( makes a distinction between current earnings and
stock prices) the info contained on stock prices—not just the firms performance in the
current period—but what it expects in the future periods.
- -The losses sustained by major companies in the US had less to do with the failure with
the US governance system but more so to the vigorously competitive environment in
which the US firms operate; he contented that the ultimate discipline for managers for
firms in the US- wouldn’t come from concentrated ownership as believe to be the case
in the relationship based system—ultimate discipline would come from competitiveness
– managers of other firms- including foreign firms competing vigorously against each
others
- These main banks taking equity position in these companies can be good for the banks
when the stock market is booming (e,g- case in the 1980s) However, when the stock
market collapses ( as in the case of Japan in 1989) , the disappearance of these equity
reserves can indeed threatened he solvency of the banks.
- Relationship base system may be too long term and banks may take time to act
 Other

Relationship based system can also bring out losses –continue to escalate commitments to a failing
project. It presents a timing issue.

EMPERICAL EVIDENCE

THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE AND THE FIRMS PERFORMANCE

- PG 48

Impact of corporate governance on firms performance

-Issue- measuring the variables – how do we capture it in a quantifiable way; CHECK

SECTION 2.3- END OF PG 48.
-Focus on board of directors
- corporate governance index is provided – corporate governance measure is provided
by an index- many other variables impact on firms performance

Pg 49-50

PG 51