In the 1980s, an unprecedented number of public corporations and divisions of public companies went private in leveraged buyouts (LBOs), partly fueled by the development of the junk bond market. LBO activity increased from $1.4 billion in 1979 to $77 billion in 1988. The last six years (from the year 2000) have seen the resurgence in going private transactions, but fueled this time by the development of the private equity market. U.S private equity firms are expected to raise $225 billion in 2006 up from $159 billion raised in 2005. Given the size and growth of this market, it is important to understand the economic forces that determine which firms choose to use private equity and opt out of public markets. The goal of our study is to determine the factors that drive the going private decisions of firms.
This paper is not the first to investigate going private transactions. DeAngelo, DeAngelo, and Rice (1984a,b), Lehn and Poulsen (1989) and Kaplan (1989a, 1989b, and 1991) study the gains from leverage buyouts in the 1980s and show that agency problems and tax benefits explain the value gain to these transactions. This paper complements these studies by focusing on the factors driving going private decisions and expands on these studies by considering a much broader set of factors, employing a longer sample period, and examining the entire public life of the firms prior to going private. In order to fully understand the costs and benefits of being a public firm, we draw on the insights from the large theoretical literature which has developed in the last decade, after these studies were published. These studies weigh the costs and benefits of being a public versus private firm to explain why firms go public.
Of course, to draw on the theories of going public to get insight into going private, it is important that the theories of going public are reversible. Many (but not all) of the costs and benefits modeled in these papers are reversible and thus not only explain why firm go public but also provide insight into why firms go private. Each of these going public theories emphasizes the tradeoff between different economic forces that confer costs and benefits of going and being public. We focus on the costs and benefits of being (rather than going) public since these factors are reversible. For example, the tradeoff between economic force X (say, liquidity benefits of being a public firm) and economic force Y (say, the costs of losing control in decision making) could be the tension in a model that generates predictions on the going public decision.
In this example, when the benefits of liquidity exceed the cost of having lesser control in decision making, firms go public. We argue that since the nature of the theories of going public are tradeoff type theories, the reverse is also true. When the costs of having lesser control exceed the benefits of liquidity, firms will reverse their decision, i.e., firms will exit the public markets and go private. Thus, by systematically reversing many of the predictions of the going public theories and examining firms’ decisions to go private, we can determine which factors drive the choice between being a private or a public firm and test their validity empirically. We also supplement these factors with the free cash flow (agency) considerations emphasized by the earlier going private studies in our analysis.
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Why Do Firms Use Private Equity to Opt Out of Public Markets?
