Project Details
Abstract
Leveraged buyouts (LBOs) are the most fascinating and controversial merger
and acquisition transactions. In an LBO, the acquirer can buy a company’s shares by
using large amounts of debt to finance the acquisition. The debt will be repaid by
using cash flows generated from the target company’s operation or by selling the
company’s so-called “non-core” assets. If the debt is fully repaid eventually, the
acquirer will take over the target company, which has been acquired with money of
the target firm, not the acquirer.
The modern LBO transaction usually proceeds in two stages. First, the acquirer
creates a shell corporation to obtain debt from a bank, or issues high-yield bonds (the
so-called “junk bonds”) to finance the acquisition of the target company. Once the
shell corporation owns a significant portion of the target company’s shares, the
acquirer can merge the target company with the shell company. As a result, debt will
be automatically transferred from the shell company to the target firm.
Since LBOs increase the debt ratio of the target company, the debt serving
obligations associated with high leverage can provide valuable governance by acting
as a discipline on management. High debt levels also mean benefits of tax
deductibility of interest charged. One subset of LOBs is management buyout, in
which the management, usually accompanied by a private equity fund, purchases the
target’s shares and drives the minority shareholders out of the company through a
cash-out merger (also known as freezeouts). Consequently, the combination of
management and ownership largely reduces agency costs.
However, high leverage increases the risk incurred by “old” creditors. The “new”
creditors end up sharing the company’s assets with the “old” creditors in the event of
bankruptcy; this occurrence reduces the expected recoveries of the “old” creditors if
the company defaults. Also, the privatization or freezeout transactions associated with
management buyouts can harm the minority shareholders resulted from information
asymmetry. The management may take the advantage of equipping information that
the minority shareholders cannot access.
In recent years, as LBO activities have risen to unprecedented levels in U.S. and
European markets, they also became more active in Taiwan. Private equity (PE) funds
have conducted acquisitions of several local banks through syndicated loans. However,
in 2008’s financial tsunami, the market prices of these shares, which acted as
collateral, fell far below the estimated value due to the high debt-to-equity ratio of the
acquired banks. In addition, a management buyout of a computer ancillary equipment
manufacture represented another unusual case. The management squeezed out of
minority shareholders through a two-tier merger transaction, assisted by a PE fund
and investment banks in 2007, and became private. Nevertheless, less than three years
later, the company announced that they would seek to go public again.
Therefore, legal control is needed to screen out the inefficient buyouts from
efficient ones. The regulation of LBOs can be found in two completely different
approaches: an ex post remedy and an ex ante approval. The demerit of the former is
the high cost of adjudication; however, the danger of the latter is the risk of
over-killing. The most appropriate regulation approach depends on the conditions of
local capital market and judicial systems.
Project IDs
Project ID:PF10007-1693
External Project ID:NSC100-2410-H182-006
External Project ID:NSC100-2410-H182-006
Status | Finished |
---|---|
Effective start/end date | 01/08/11 → 31/07/12 |
Keywords
- leveraged buyout
- management buyout
- management buy-in
- private equity firm
- private equity fund
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