The Causes and Consequences of Private Equity Buyouts of Private Firms: Evidence from U.S. Corporate Tax Returns

Jonathan B. Cohn, Erin Towery
2013 Social Science Research Network  
This paper uses corporate tax return data to study the determinants and consequences of private equity (PE) buyouts of U.S. private firms between 1995 and 2009. In contrast with prior evidence that PE acquirers target public firms facing overinvestment problems, we find that PE acquirers target private firms facing underinvestment problems due to financing constraints. We then provide evidence that PE buyouts create value through their real effects on private firms in two ways: by leading to
more » ... s: by leading to operational turnarounds in struggling firms and by relaxing financing constraints that limit the exercise of growth options in healthier firms. JEL Classification codes: G34, G32, H25 Private equity (PE) firms play a key role in the market for corporate control. Although PE buyouts of publicly-traded firms receive more attention in the press, buyouts of private firms are far more common (Davis et al. (2013) ). However, little is known about the motivations for and consequences of these buyouts as private firms, at least in the U.S., are generally not required to disclose financial information. We fill this void by analyzing PE buyouts of private firms using confidential data from U.S. corporate tax returns, which all U.S. corporations, public or private, must file. We use these data to study the determinants of private firm buyouts, as well as how operating performance, sales growth, and financial structure change around these transactions. In doing so, we shed light on the motives for these buyouts and the means through which PE firms create value. Studying private firm buyouts is important not only because of the size and growth of this market, but also because the factors driving these transactions likely differ from the factors driving public firm buyouts. On the one hand, traditional arguments that PE buyouts create value by mitigating agency conflicts within firms (e.g., Jensen (1989)) do not apply well to buyouts of private firms, where separation of ownership and control is already limited. On the other hand, if PE specialists possess professional management skills, these skills should be more valuable in private firms, many of which are run by founders or their families. In addition, because private firms have fewer options for raising capital, the financial resources of a PE buyer could create value by relaxing financing constraints that limit these firms' growth. 1
doi:10.2139/ssrn.2318916 fatcat:xi4d7exsh5h5rmeotvpcjyw3oq