Abstract
Managers in management leveraged buyout (MBO) firms prefer to purchase their firms at a low offer price. This motive gives them a clear incentive to make pessimistic discretionary disclosures. Using a sample of press releases, I find that managers involved in their firms’ MBO selectively release negative disclosures to denigrate their firm just before the MBO transaction when compared with prior period: they issue more bad news disclosures and more pessimistic quotes. Additionally, they issue less optimistic quotes, fewer good news disclosures, less positive earnings forecasts, and they manage earnings downwards. I control for factors that may not be caused by managers’ purchase motives by comparing the MBO sample with a third-party leveraged buyout sample where management is not involved in the buyout and with a performance-matched control sample. I find that the disclosure of MBO firms becomes significantly more pessimistic than the leveraged buyout firms where management is not involved in the transaction and significantly more pessimistic than the performance-matched control sample.
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Notes
Throughout the paper, I use the term “LBO” to refer exclusively to leveraged buyouts where management is not involved and “MBO” to refer to leveraged buyouts where only management is involved.
Regardless of the involvement in the deal itself, the post-buyout management team’s equity stake is usually disproportionately high to compensate them for the disproportionately high risk and effort that they must assume (DeAngelo et al. 1984).
DeAngelo et al. (1984) find an average premium of 56% over the day earlier share price. I find median premiums of 46.43% and 24.58% over the day earlier share prices in the MBO and LBO samples, respectively.
Many leveraged buyout companies are small and therefore do not release press releases to services such as Reuters or Dow Jones newswires. As my search is based on the firm’s name at the time of the buyout, the dropping of these firms cannot be due to a name change (as would be the case in Compustat).
Other measures of size, risk, growth and Investment opportunity set such as book value, total assets and book-to-market ratio were substituted for MVE and the results were qualitatively similar.
Note that although this scenario is possible, my results show that managers on average who were more optimistic were less pessimistic at the same time.
Analysis is not sensitive to using net income (Item #69) rather than income before extraordinary items.
Autocorrelation is tested using the Generalized Durbin–Watson and Beruch–Godfrey tests.
Other serial correlation correction methods of estimation such as Estimated Generalized Least Squares (EGLS) using the Yule-Walker method (a variation of the Cochrane-Orcott method where the first observation is retained) produce similar results.
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This paper is based on Nader Hafzalla’s dissertation research at the University of Michigan. Nader died unexpectedly on June 29, 2006. He was a great student, a loyal friend and a ton of fun. His dissertation committee members are Russell Lundholm (chair), Patricia Dechow, Richard Sloan, and Sugato Bhattacharyya. Nader also received help on this work from all the faculty and doctoral students at Michigan, particularly Peter Demerjian, Michelle Hanlon, Sarah McVay, Venky Nagar, Cathy Shakespeare, Doug Skinner, Mark Soliman and Matt VanWinkle. We all miss him.
Appendices
Appendix A
Panel A: Key words used to determine tone in managerial quotes | |
|---|---|
Optimistic | Pessimistic |
Happy | Unhappy |
Pleased | Displeased |
Encouraged | Discouraged |
Remain positive | Hopeless |
Positive | Negative |
Optimistic | Pessimistic |
Excited | Unexcited |
Proud | Disappointed |
Positive Future Outlook | Grim Future Outlook |
Panel B: Examples of good and bad additional details | |
|---|---|
Good News | Bad News |
New product release or development | Loss of contract or major customer |
Advancing to a new phase of testing or government approval of a product | Major layoffs or restructuring |
Increases in dividend payments | Reduction in dividend payments |
Opening of new stores or branches | Closing of stores, branches, or facilities |
Litigation brought against the firm | |
Unexpected increases in monthly sales or earnings | Unexpected decreases in monthly sales or earnings |
New contract or alliance intended to improve performance | Write-downs of assets |
Appendix B: Examples of managerial quotes
1.1 Optimistic disclosures
1.1.1 MascoTech Corp on February 28th, 2000—Bad performance
MascoTech’s CEO Frank M. Hennessey commented, “Although we continue to be impacted by softness in certain of our markets, we are particularly pleased with the growth in 1999 experienced by our North American Metal Forming operations and our Towing Systems Group. We are seeing signs of improvement in our other business segments and are optimistic that the growth initiatives that we are pursuing will result in long-term value creation.”
1.1.2 Intermetrics Inc. on June 28th, 1994—Good performance
“I am optimistic,” Saponaro continues, “about the long-term prospects for the company. Backlog continues at a high level of $114 million, reflecting current contract awards with new customers involving substantial multi-year initiatives to upgrade, expand and re-engineer information and information related systems. Given the strength of the backlog and anticipated new contract awards, the company expects to report steadily improving results over the first quarter for the remaining nine months of fiscal year 1995.”
1.2 Pessimistic disclosures
1.2.1 Besicorp Inc. on February 17th, 2000—Good performance
According to James E. Curtin, vice president and controller, “The increase in revenues in the three and nine months ended December 31, 1999 from the corresponding periods in the prior year represents an increase in photovoltaic product sales ... No assurance can be given that revenues or gross margins will remain at current levels.”
1.2.2 Amtran Inc. on January 30th, 2001—Bad performance
“We faced several difficult challenges in the fourth quarter,” said John Tague, Amtran’s president and chief executive officer.... “We are obviously disappointed in our bottom-line results for the quarter, as well as the year.”
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Hafzalla, N.M. Managerial incentives for discretionary disclosure: evidence from management leveraged buyouts. Rev Account Stud 14, 507–533 (2009). https://doi.org/10.1007/s11142-007-9061-0
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DOI: https://doi.org/10.1007/s11142-007-9061-0