Insight Private Equity on the black box of restructuring tools private equity investors use to improve the operational performance of their portfolio companies

Insight Private Equity

Andrej Gill Goethe University Frankfurt – Faculty of Economics and Business Administration

Nikolai Visnjic Goethe University Frankfurt

June 18, 2013
SAFE Working Paper No. 23

Abstract: 
We are able to shed light on the black box of restructuring tools private equity investors use to improve the operational performance of their portfolio companies. By building on previous work considering performance evaluation of PE backed companies, we analyze whether private equity improves operating efficiency and which of the typical restructuring tools are the main performance drivers. Using a set of over 300 international leveraged buyout transactions of the last thirty years, we find that while there is vast improvement in operational efficiency, these gains vary considerably. Our top performing transactions are subject to strong equity incentives, frequent asset restructuring and tight control by the investor. Furthermore, investors’ experience has a positive influence while financial leverage has no influence on operational performance.

Unethical Culture, Suspect CEOS, and Corporate Misbehavior

Unethical Culture, Suspect CEOS, and Corporate Misbehavior

Lee Biggerstaff  University of Tennessee, Knoxville – Department of Finance

David C. Cicero University of Alabama – Culverhouse College of Commerce & Business Administration

Andy Puckett University of Tennessee, Knoxville

June 2013

Abstract: 
We show that firms with CEOs who personally benefited from options backdating were more likely to engage in other forms of corporate misbehavior, suggestive of an unethical corporate culture. These firms were more likely to overstate firm profitability and to engage in less profitable acquisition strategies. The increased level of corporate misbehavior is concentrated in firms with suspect CEOs who were outside hires, consistent with adverse selection in the market for chief executives. Difference-in-differences tests confirm that the propensity to engage in these activities is significantly increased following the arrival of an outside-hire ‘suspect’ CEO, suggesting that causation flows from the top executives to the firm. Finally, while these suspect CEOs appear to have avoided market discipline when the market was optimistic, they were more likely to lose their jobs, and their firms were more likely to experience dramatic declines in value during the ensuing market correction.

Z-Score Models’ Application to Italian Companies Subject to Extraordinary Administration

Z-Score Models’ Application to Italian Companies Subject to Extraordinary Administration

Edward I. Altman New York University (NYU) – Salomon Center; New York University (NYU) – Department of Finance

Alberto Falini University of Brescia – Department of Economics

Alessandro Danovi University of Bergamo (Italy)

May 1, 2013
Bancaria No. 04-2013

Abstract: 
It is normal for companies, during their life cycle, to alternate between positive and negative phases, periods of success and failure. When a negative period shifts from temporary to structural and chronic (and thus continues over time), the company is often destined to go bankrupt. The uncertainty regarding the exact moment when this takes place has brought about a plethora of quantitative and qualitative models aimed at predicting bankruptcy. This study applies the most well-known of these models, the Z-Score, through an application to Italian companies subject to extraordinary administration between 2000 and 2010. The results confirm a good predictive effectiveness, though Italian peculiarities could require the development of ad hoc parameters.

Is the CEO’s In-House Experience Informative About Audit Risk?

Is the CEO’s In-House Experience Informative About Audit Risk?

Paul Brockman Lehigh University

Gopal V. Krishnan American University; American University – Kogod School of Business

HyeSeung Lee Lehigh University – Department of Accounting

Jesus M. Salas Lehigh University

June 19, 2013

Abstract: 
Very little is known about whether personal characteristics of senior managers convey information about audit risk. We focus on one characteristic of the CEO, the number of years the CEO has worked in the firm before becoming the CEO (CEO in-house experience). We posit that the CEO’s in-house experience mitigates audit risk due to less uncertainty and more familiarity with the auditor. Using audit fees to proxy for audit risk, we find that audit fees are decreasing in CEO’s in-house experience. On average, audit fees are lower by 10% when CEO in-house experience changes from 2 to 6 years. Further, the relation between audit fees and the CEO’s in-house experience is conditional on the overall quality of corporate governance. While the CEO’s in-house experience is insignificant in firms with good governance, it is strongly significant in firms with weak governance.

When Blockholders Leave Feet First: Do Ownership and Control Affect Firm Value?

When Blockholders Leave Feet First: Do Ownership and Control Affect Firm Value?

Bang Dang Nguyen University of Cambridge – Judge Business School

Kasper Meisner Nielsen Hong Kong University of Science & Technology – Department of Finance

June 26, 2013

Abstract: 
This study investigates the effect of ownership and control on firm value using exogenous variation resulting from stock price reactions to the sudden death of individual blockholders. Stock market reactions range from -5% to 4% for inside blockholders as ownership increases and from 0% to -2% for outside blockholders. The difference in market reactions identifies the value of ownership and control while effectively controlling for confounding effects on firm value due to liquidity or anticipated takeover activity. Overall, our results suggest that as ownership increases the beneficial effect of inside blockholders disappears while the beneficial effect of outside blockholders increases.

Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

Gil S. Bae Korea University – Department of Accounting

Sanjay Kallapur Indian School of Business

Joon Hwa Rho Chungnam National University – College of Business

June 18, 2013

Abstract: 
In this paper we provide evidence on specific factors that could affect audit quality under mandatory rotation, using data from Korea where mandatory auditor rotation was put into effect in 2006. We find no evidence supporting the “Brillo pad effect” (the argument that departing auditors have incentives to clean up the balance sheet) or the “new broom effect” (the argument that new auditors can find problems that long-standing auditors tend to overlook). On the contrary, departing auditors spend fewer hours just before rotation, consistent with a lack of incentives to maintain quality given the impending rotation. Compared to clients in other mandatory rotations, the clients rotating away from industry specialist auditors have higher audit hours and higher absolute discretionary accruals post-rotation, suggesting there are adverse effects from breaking such auditor-client pairings. Finally we find that Big 4 auditors’ market share continues to increase after mandatory rotation is imposed. Our findings therefore fail to support mandatory rotation.