Why do private acquirers pay so little compared to public acquirers?

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Abstract

Using the longest event window, we find that public target shareholders receive a 63% (14%) higher premium when the acquirer is a public firm rather than a private equity firm (private operating firm). The premium difference holds with the usual controls for deal and target characteristics, and it is highest (lowest) when acquisitions by private bidders are compared to acquisitions by public companies with low (high) managerial ownership. Further, the premium paid by public bidders (not private bidders) increases with target managerial and institutional ownership.

Introduction

The significant participation of private firms in general and private equity firms in particular in the market for corporate control over recent years has drawn much attention in the press. In 2005, 15% of the total deal value of U.S. mergers and acquisitions came from private equity deals and 18 of the top 100 deals were private equity deals.1

Though the press has emphasized the relative importance and growing role of private bidders in the takeover market, academic research has devoted little attention to these bidders. For example, we know of no systematic evidence on whether the gains to target shareholders differ when the acquirer is a private firm rather than a public firm. Yet both academics and the press have suggested reasons why private bidders might behave differently from public bidders. Academics have emphasized that the incentives of private equity firm managers are much more high-powered than those of public firms (see, e.g., Jensen, 1989). There is much debate in the press about whether private equity firms get away with paying lower premiums because target management colludes with the acquirers.2 In this paper, we provide evidence on how the premiums paid by private acquirers compare to the premiums paid by public companies.

Since a private firm does not have publicly traded equity to offer in an acquisition, it is not surprising that most acquisitions by private firms are cash deals. Therefore, to make an apples-to-apples comparison, it is necessary to compare premiums for cash offers by private firms to premiums for cash offers by public firms. Using a sample of completed cash-only deals during the period 1980–2005 consisting of 453 deals by private bidders and 1,214 deals by public bidders, we find a sizable difference in premiums between the two types of acquisitions, measured as in Schwert (1996) from pre-announcement runup to completion. In our sample, the average premium for target shareholders when the bidder is a public firm is 46.5%. The average premium when the acquirer is a private operating company is 40.9%, and it is only 28.5% when the acquirer is a private equity firm, so that the premium for an acquisition by a public firm is 63.3% higher than for an acquisition by a private equity firm. Similar results hold for other premium measures.

Why are there such differences in the gains to target shareholders between acquisitions by public firms versus private firms? The simplest explanation is that public firms and private firms acquire different types of firms. With such an explanation, target shareholders do not necessarily receive less if a private firm acquires their firm than they would if a public firm made the acquisition. One might also argue that acquisitions by public firms generate more shareholder wealth because public firms are operating companies, so that such acquisitions would have synergy gains that are shared with the target. Similarly, private equity firms acquire firms for which synergy gains are nonexistent, and hence premiums for the acquired firms are not driven as high as the premiums that public firms pay.

Nonetheless, we find that for most premium measures private operating companies pay less than public firms (47.9% of the private bidders in our sample are operating companies). Whether private operating companies pay more than private equity companies depends on the measure of the premium used. If we use a premium estimated from the pre-announcement runup to completion, private operating companies pay more than private equity companies. If, instead, we use a 3-day announcement return, there is no premium difference. Further, when we take into account target and deal characteristics, private operating companies pay less for acquisitions than public companies irrespective of the premium measure, but whether they pay more than private equity firms depends on the premium measure used. It is clear, however, that there is support for an important role for synergy gains in explaining the premium difference when we use premiums estimated over a long window.

A vast literature shows that differences in firm and deal characteristics help explain differences in target gains. Controlling for target and deal characteristics does not reduce the difference in target premiums between private acquisitions and public acquisitions. If observable target and deal characteristics do not explain the difference in premiums, either target and deal characteristics we cannot observe with our dataset explain the difference or private bidders and public bidders make different offers for similar firms. There are at least two possible explanations for why offers would depend on the organizational form of the bidder. First, failure of an offer has more adverse consequences for managers of public firms than for managers of private firms.3 In particular, public firms might have to reveal more information about their strategy in the process of making an offer, which could possibly help competitors and perhaps make it more likely that an unsuccessful acquirer becomes a target. However, Lehn and Zhao (2006) find that managers are more likely to keep their jobs if they cancel an offer to which the market has reacted poorly instead of going through with the acquisition. Second, as advanced by Jensen (1989) and others, agency problems might be more serious in many public firms than in private firms. There is a long tradition in finance, starting with Berle and Means (1932), questioning whether managers with low firm ownership make decisions that go against the interests of shareholders. This tradition emphasizes the potential for managers to gain from acquisitions that do not benefit shareholders. In particular, managers can gain in prestige from managing larger firms, receive more perks, be better compensated, and be safer from hostile takeovers.

To address the agency view, we examine the difference in target premiums between private bidders and public bidders with highly concentrated managerial ownership (defined broadly as ownership by insiders). The difference in target shareholder gains is highest when acquisitions by private equity firms are compared to acquisitions by public firms with managerial ownership of less than or equal to 1% and insignificant when private equity firm acquisitions are compared to acquisitions by public firms with managerial ownership in excess of 50%. In addition, private firms differ from the bidding behavior of public firms in that private firms are much less reluctant to walk away from a deal than are public firms—while 37.4% of the offers by private firms are withdrawn, only 16.9% of the offers by public firms are withdrawn. This evidence is consistent with the hypothesis that failure is more costly for public firms, but it could also reflect greater agency costs in the typical public firm relative to private firms or a greater willingness of private firms to make offers that have little chance of success.

We also investigate the hypothesis that target shareholders are somehow cheated in acquisitions by private firms because target managers are willing to sell to private bidders at a lower price. Such an argument makes sense if a private acquirer can offer the promise of continued employment to target managers along with the possibility of a large payoff if they improve the firm enough that it eventually goes public again. With this hypothesis, however, we expect that the difference in shareholder gains falls as the share ownership of target managers increases because, as their stake increases, they lose more from a low acquisition premium. We also expect the premium difference to fall as institutional ownership increases because institutional shareholders have greater ability and incentives to force management to seek improvements in the premium offered. We find that target shareholder gains are higher for firms with greater managerial ownership, but only for our long-horizon premium estimates. When we allow the relation between the shareholder gains and target ownership to depend on the type of acquirer, we find weak evidence that target managerial ownership drives up the premium for acquisitions by public firms but not by private firms. Institutional ownership in the target firm leads to higher premiums for public acquirers but has no impact on premiums when the acquirer is a private firm. It could well be that private firms make acquisitions only if the target management is cooperative, possibly because of private gains from the acquisition, and such cooperation from target management weakens the efforts of institutional investors to increase the premium. Supporting this perspective, we find that no private equity acquisition in our sample is hostile.

The remainder of the paper is organized as follows. In Section 2, we describe our sample of acquisitions by private and public firms. In Section 3, we compare target gains for acquisitions by private firms and by public firms. We also compare the target gains for acquisitions by different types of private firms. In Section 4, we control for target and deal characteristics. Section 5 examines the relation between premium differences and ownership concentration at public firms. In Section 6, we examine whether premium differences are related to target managerial and institutional ownership. We conclude in Section 7.

Section snippets

The sample of acquisitions

We collect our sample of acquisitions from the Securities Data Company's (SDC) U.S. Merger and Acquisition Database. To obtain a sample where offers are most comparable between types of acquirers, we collect all completed majority acquisitions for the period 1980–2005 between U.S. public targets and U.S. bidders in which the acquirer owns 100% of the shares of the target after the deal. We exclude all transactions with non-operating targets, without disclosed deal value, and labeled as

Gains to target shareholders for public bidders and private bidders

We use the CRSP database to collect daily return data for our sample of targets. To measure the premium received by the target, we estimate size and book-to-market portfolio-adjusted buy-and-hold abnormal returns from 42 days before the first bid to completion (FBC premium) using the returns on the 25 Fama-French size and book-to-market portfolios (our results are similar if we use market-model cumulative abnormal return measures). As Schwert (1996) notes, this approach to estimating the

Can target characteristics explain the difference in premiums?

In this section, we investigate whether private firms acquire different types of firms and structure deals differently than public firms and whether these differences explain the difference in target premiums. We focus on target and deal characteristics that the empirical and theoretical literatures have found important. We first explore these characteristics at the univariate level in Section 4.1 and then continue with multiple regression analyses in Section 4.2.

Bidder characteristics and the gains to target shareholders for public bidders and private bidders

So far we have shown an economically large and statistically significant difference in target shareholder gains between acquisitions by private firms and acquisitions by public firms. Observable target and deal characteristics do not explain this difference. We now investigate whether the lower shareholder gains in acquisitions by private firms can be explained by differences in bidder characteristics. In contrast to public acquirer deals, such an investigation is necessarily limited by the

Can the incentives of target managers explain the return difference?

A concern mentioned in the press is that managers of private firms have two advantages over managers of public firms. First, they are not subject to the greater monitoring that comes from having to report quarterly results and dealing with the laws and regulations that affect public firms. At a time when there is much discussion about the costs of Sarbanes-Oxley, managers of private firms are not affected by these costs. Second, managers of private firms can earn an outsized payoff when the

Conclusion

In this paper, we find that target shareholders gain both statistically and economically if a public firm makes the acquisition. Using a premium measure that includes the pre-bid period as well as the period from the first bid to completion as in Schwert (1996), we find that target shareholders earn 35% higher premiums if a public firm makes the acquisition rather than a private firm. Target shareholders earn 63% higher premiums with public bidders rather than private equity bidders.

We

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    Part of this research was conducted while Stulz was visiting the University of Southern California. We thank Henrik Cronqvist, Ken French, Jeff Gordon, Calvin Johnson, Steve Kaplan, an anonymous referee, seminar participants at the University of Pittsburgh and the Ohio State University, and participants at the 2007 New York Society of Quantitative Analysts Conference for valuable comments. Manoj Kulchania provided useful research assistance.

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