Corporate managers, bankers, and policy makers alike have expressed concerns that the recent dearth of initial public offerings (IPOs) has caused a breakdown in the engine of innovation and growth. In the paper, Does Going Public Affect Innovation?, which was recently made publicly available on SSRN, I explore whether the transition to public equity markets indeed affects innovation, and if so, how. Theoretically, the effect of IPOs on innovation is ambiguous. On the one hand, going public provides improved access to capital that may allow firms to enhance their innovative activities; on the other hand, market pressures and potential departure of employees following the IPO may lead to opposite results.

To answer this question, I use standard patent-based metrics to capture changes in innovative activity in the years around the IPO and focus on three important dimensions of firms’ innovative activity: internally generated innovation, the productivity and mobility choices of individual inventors, and the acquisition of external innovation.

…continue reading: IPOs and Innovation

Weil, Gotshal & Manges LLP recently conducted our fifth annual survey of sponsor-backed going private transactions. Weil surveyed 60 sponsor-backed going private transactions announced from January 1, 2010 through December 31, 2010 with a transaction value (i.e., enterprise value) of at least $100 million (excluding target companies that were real estate investment trusts).

Thirty-nine of the surveyed transactions in 2010 involved a target company in the United States, thirteen involved a target company in Europe and eight involved a target company in Asia-Pacific. The publicly available information for certain surveyed transactions did not disclose all data points covered by our survey; therefore, the charts and graphs in this survey may not reflect information from all surveyed transactions.

With a significant rebound in the availability of debt financing for new acquisitions, 2010 was a strong year for sponsor-backed going private transactions in the United States. Thirty-nine sponsor-backed going private transactions in the United States were announced over the course of 2010.

…continue reading: Surveying Sponsor-Backed Going Private Transactions

In our paper, Corporate Governance of LBOs: The Role of Boards, which was recently made publicly available on SSRN, we study whether the success of private equity-backed firms is due to their superior corporate governance or instead due to financial engineering. We focus in particular on the role of boards in LBOs and look at changes in the board when a public company is taken private by a private equity group.

We construct a new data set, which follows the board composition and financial figures of all public to private transactions that took place in the UK between 1998 and 2003. Out of these 142 transactions, 88 have private equity sponsors and are thus identified as LBOs. The remaining transactions are either pure MBOs or other types, and are used as benchmarks. We track each company two or three years before the announcement of the buyout until the exit of private equity investors or until 2010, whichever is earlier.

We find that when a company goes private, fundamental shifts in board size and composition take place. The board size decreases on average by 15% and the presence of outside directors is drastically reduced, as they are replaced by individuals employed by the private equity sponsors. We also find evidence that the board size and presence of LBO sponsors on the board depend on the “style” or preferences of the private equity firm. Overall, the boards become more in line with the type of boards that the corporate governance literature would identify as exhibiting better corporate governance. We then set to find out what role these boards play.

…continue reading: Corporate Governance of LBOs

The acquisition of Del Monte Foods Co. by a group of financial buyers was completed earlier this month. [1] The shareholder vote, which took place in early March, had been delayed for twenty days by the Delaware Court of Chancery because the court found that the financial advisor to Del Monte’s board had failed to disclose important information to the board and had become so conflicted in the transaction that the entire process had become tainted by the financial advisor’s misconduct and the directors’ breach of their fiduciary duties. [2]

The Del Monte transaction highlights important considerations for companies pursuing sale transactions, whether in the context of a going-private transaction or a sale to a strategic acquiror. One set of issues centers around the board’s oversight of its financial advisors, and another concerns the appropriate use of special committees by boards. The opinion of Vice Chancellor Laster in the Del Monte case is a powerful reminder to directors that actions such as hiring advisors and forming special committees—while appropriate and even essential in some circumstances—do not obviate the need for members of the board to be fully engaged in and actively supervising the process of negotiating a significant company transaction.

…continue reading: Del Monte and the Responsibility of a Board in a Sales Process

The pot of multi-forum stockholder litigation against deals continues to boil. The recent Allion decision, the subject of our recent memo, spotlights one solution that our Firm developed that has shown some promise.

That litigation follows in the wake of a deal’s announcement is nothing new. But participants in the M&A markets are still grappling with the increasingly prevalent trend of multiple shareholder actions challenging the same deal in different courts. The Delaware Court of Chancery recently endorsed a pragmatic solution to this endemic problem. In re Allion Healthcare Inc. S’holders Litig., C.A. No. 5022-CC (Del. Ch. Mar. 29, 2011).

…continue reading: Delaware Court of Chancery Addresses Multi-Forum Deal Litigation

In the paper, Does Capital Market Myopia Affect Plant Productivity? Evidence from Going Private Transactions, which was recently made publicly available on SSRN, we hypothesize that if capital markets pressure listed firms to be myopic in a way that impacts efficiency (an influential criticism of the stock market oriented U.S. financial system), then going private (when myopia is eliminated) should cause U.S. firms to improve their establishment level productivity relative to a peer control groups of firms.

…continue reading: Capital Market Myopia and Plant Productivity

In a recent Delaware decision issued in In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL (Del Ch. May 25, 2010), Vice Chancellor Travis Laster imposed additional requirements for controlling stockholders and boards to obtain the benefit of the more deferential business judgment standard of review by a court in litigation over a going private tender offer, and advocates a unified standard of review for going private transactions generally, whether structured as a merger or a tender offer. Vice Chancellor Laster endorsed the reasoning first set forth in dicta in Cox Communications (Del. Ch. 2005), in which Vice Chancellor Leo Strine, Jr. argued that the Delaware courts should reject the notion that negotiated mergers with controlling stockholders are subject to the stringent “entire fairness” review, while certain two-step transactions (i.e., a tender offer followed by a short-form merger) with the same controlling stockholders are subject to the business judgment rule. In CNX, Vice Chancellor Laster held that the business judgment rule (and not entire fairness) will apply to a going private transaction by its controlling stockholder only if the transaction is both (1) negotiated and recommended by an active and informed special committee of independent, disinterested directors and (2) subject to a “majority-of-the-minority” tender or vote condition.

…continue reading: Delaware Court Adopts Unified Standard for Controlling Stockholder Going Private Transactions

In our forthcoming Review of Financial Studies paper Financial Visibility and the Decision to Go Private we investigate the determinants of the decision to go private over a firm’s entire public life cycle.

We investigate the decision to go private by estimating several variations of the hazard model. Initially, we estimate a broad competing risk model where the decision to remain public or go private is evaluated against all alternative termination outcomes (merger, liquidation, or negative delisting). Most of our analysis, however, focuses on estimating a hazard model that excludes all other competing choices. In this case, the regression sample consists of an annual panel of observations of all IPO firms that either had an LBO or were bought by another private company and all surviving IPO firms that remained in the public market.

Our sample includes completed deals in which an IPO firm was a target in an LBO or was acquired and became a private company from January 1, 1990, to the end of October 2007. Our tests focus on those firms that 1) went public after 1988 and subsequently were buyout targets after January 1, 1990 and 2) were included in Compustat. Our final sample consisted of 262 firms (169 LBO targets and 93 non-LBO firms that were acquired by nonpublic companies or investor groups). Of these 262 IPO firms, 218 (150 LBO and 68 non-LBO targets) were followed by securities analysts.

Our evidence reveals that firms with declining growth in analyst coverage, falling institutional ownership, and low stock turnover were more likely to go private and opted to do so sooner. We argue that a primary reason behind the decision of IPO firms to abandon their public listing was a failure to attract a critical mass of financial visibility and investor interest. Consistent with the findings of earlier literature, we also find strong support for Jensen’s free-cash-flow hypothesis, which argues that these corporate restructurings are a useful tool in capital markets for mitigating agency problems between insiders and outside shareholders.

The full paper is available for download here.

In our paper, The Robustness of the Sarbanes Oxley Effect on the U.S. Capital Market, which was recently accepted for publication in the Review of Accounting Studies, we re-evaluate the effects of the Sarbanes Oxley Act (SOX) on the number of exchange-traded firms in the U.S. capital market, taking into account general market conditions and firm fundamentals, especially size and financial performance.

We start by developing a model to predict new listings based on conditions in U.S. markets for products and capital, and then invert that model to predict de-listings over time. We analyze a comprehensive dataset of new listings and de-listings from U.S. national stock exchanges over 44 years. We find that market factors that explain the frequency of new listings on U.S. exchanges from 1962 through 2005 also explain most of the variance in the frequency of de-listings over the same time period. The peak in the number of delisted firms and the rate of de-listings was in 2001. In addition, the frequency of de-listings has continued at high levels relative to the historical average subsequent to the passage and implementation of SOX. Our time series analysis uses an indicator variable as a proxy for the passage of SOX, and the SOX variable is not associated with abnormal levels of de-listings in general, conditional on market factors. However, our proxy for the implementation of SOX Section 404 in 2004 is associated with a significant decline in de-listings, contrary to the prior finding of SOX effects resulting in increased de-registrations based on shorter time series and more restrictive definitions of firms exiting the U.S. public capital market.

Next we look for changes in the propensity to delist by estimating firm-specific models including the general market conditions from our first set of tests, firm fundamentals, and the SOX proxies. We use a sample composed of all U.S. firms listed on national stock exchanges during the period 1962 to 2005. We find that the passage of SOX is associated with increased probability of delisting for publicly traded U.S. firms, but only when proxies for general market conditions are not included in the model. The implementation of SOX section 404 (for the largest firms in the U.S. capital market) in 2004 is associated with a significant increase in the probability of delisting, even after controlling for general market conditions and firm fundamentals. This result is not inconsistent with recent literature documenting an increase in the probability of delisting during the SOX time period, especially for small firms (although small firms have been granted an extension on applying Section 404 that has already rolled over several times).

Finally, we disaggregate the sample of U.S. exchange-traded firms by size to replicate earlier results suggesting that small firms were especially pushed out of the public equity market. We find that prior stock return and size are significantly negatively associated with the probability of delisting for firms in all five size quintiles, meaning that smaller firms and poorly performing firms were more likely to delist across the whole time period. We also find that, for the smallest quintile of firms in the sample, the passage of SOX was only marginally associated with an increase in the probability of delisting, and the implementation of Section 404 was not associated with the probability of delisting (consistent with the delayed applicability of Section 404 to small firms). On the other hand, the passage of SOX is either not associated with or significantly negatively associated with the probability of delisting for the largest 80% of the sample, but the implementation of Section 404 is associated with an increase in the probability of delisting for all but the smallest 20% of the sample firms.

We conclude from this evidence that there is little basis for associating the increased incidence of firms delisting from U.S. markets in the first half of this decade with the passage or implementation of SOX rather than with the general worsening of market conditions. On the other hand, the implementation of SOX Section 404 has been associated with increased probability of larger firms exiting U.S. public capital markets, especially if they are performing poorly. Increasing the probability of poorly performing firms exiting the U.S. public capital markets is a different regulatory implication of SOX than is pushing small firms out of the market.

The full paper is available for download here.

The Private Equity Group at my firm has recently issued its third annual survey of sponsor-backed going private transactions. The survey analyzes and summarizes the material transaction terms of going private transactions involving a private equity sponsor in the United States, Europe and Asia-Pacific.

We surveyed 39 sponsor-backed public-to-private transactions announced from January 1, 2008 through December 31, 2008 with a transaction value (i.e., enterprise value) of at least $100 million (excluding target companies that were real estate investment trusts). Fifteen of this year’s surveyed transactions involved a target company in the United States, 13 involved a target company in Europe and 11 involved a target company in Asia-Pacific.

The survey’s key conclusions for the United States transactions include the following:

• 2008 witnessed a 97% collapse in aggregate transaction value for sponsor-backed going private transactions when compared to 2007. The largest transaction announced in 2008 had a transaction value of approximately $2.1 billion, a 95% decline from the largest transaction announced in 2007. There was also a 76% decline in transaction volume when compared to 2007.

• The percentage of club deals involving two or more private equity sponsors declined significantly in all transaction sizes in 2008. Only 7% of the 2008 transactions constituted a club deal whereas 37% of the 2007 transactions did so.

• The tender offer again made an appearance in 2008, continuing a trend that started in 2006. The same cannot be said for stub equity. There was no transaction in 2008 in which the sponsor offered stub equity to the target’s public shareholders.

• Not surprisingly, the credit crisis continued to adversely impact the debt-to-equity ratios of sponsor-backed going private transactions. Equity accounted for an average of 64% of acquiror capitalization for transactions between $100 million and $1 billion in value and 51% of acquiror capitalization for transactions greater than $1 billion in value.

• The credit crisis has forced sponsors to tap alternative financing sources, including traditional mezzanine lenders and hedge funds.

• The go-shop provision continued to be a common feature of going private transactions in 2008 with 53% of surveyed transactions including this form of post-signing market check. Interestingly, sponsors were more resistant this year to giving a significantly reduced go-shop break-up fee (only one transaction had a go-shop break-up fee of less than 50% of the normal break-up fee).

• Although far from the norm, there was an increase in 2008 in sponsor-backed going private transactions with a financing out (20% in 2008 compared to 3% in 2007).

• When compared to pre-credit crunch transactions, the 2008 transactions reveal a material decrease in the number of MAE exceptions.

• Reverse break-up fees were again the norm in 2008, appearing in 87% of all surveyed transactions (a slight increase from 84% in 2007). In an effort to limit the optionality built-in to the reverse break-up fee structure and incentivize sponsors to consummate the transaction, target boards in a significant minority of surveyed transactions negotiated for a higher second-tier reverse break-up fee or a higher cap on monetary damages.

• Interestingly, specific performance provisions enforceable against the buyer were very rare in 2008. Only 7% of the 2008 transactions permitted the seller to seek specific performance against the buyer rather than be limited to a reverse break-up fee or monetary damages (whereas 33% of the surveyed transactions in 2007 allowed the seller to seek specific performance).

The survey is available here.