Target bankruptcy risk and its impact on going-private buyout performance and exit

Abstract

Research Question/Issue: What is the impact of bankruptcy risk on whether listed corporations are likely to be bought out by private equity firms and on the subsequent exit, including bankruptcy, of private equity backed public to private buy-outs? Research Findings/Insights: Using a sample of 246 UK companies that went from public to private (P2P) company status from 1997 to 2005, we find that going private companies have significantly higher default probability. Private equity firms sponsoring P2P deals acquire firms with higher risk of bankruptcy than non-acquired firms that remain public. We find evidence that high receivership risk at going private increases the chance that the target will end up in receivership, but post-P2P bankruptcy likelihood is less when the P2P is a management buyout rather than any other form of buyout. Independent boards of pre-P2P targets promote P2P deals and reduce the chances of bankruptcy after the buyout, suggesting a good corporate governance structure makes a positive contribution to bankruptcy avoidance after going private transactions. Theoretical/Academic Implications: Our finding that P2P deals involve targets with a higher risk of bankruptcy adds to theoretical insights about private equity as, in contrast to previous research, it suggests that PE firms are not deterred by the risk of financial distress but consider it a value creating opportunity. Our use of the option pricing framework represents a first and novel attempt at measuring bankruptcy risk and its impact on the ability of private equity firms to achieve effective turnaround. We find a link between better governance of the target pre-P2P and lower bankruptcy risk since where the PE investor inherits a strong governance structure, manifested in independent boards, chances of subsequent bankruptcy are reduced. Similarly, where the P2P acquisition is a management buyout, the probability of bankruptcy, post-P2P, is reduced, suggesting lower informational asymmetries and better alignment of interests between managerial and private equity investors. Although, due to the small number of receivership exits in our sample of P2P firms, the results are not as strong as we would like, a more extended analysis involving a larger sample over a longer period, in particular of firms exiting through bankruptcy is expected to produce stronger results. Our results provide a sufficient basis to warrant such further analysis.