2. Leveraged Buyouts, Going Dark and the Change of the Trading Venue

Recent studies cast doubt on the existence of the diversification discount (e.g., Campa and Kedia 2002; Villalonga 2004a, b).

For example, the failed Drexel Burnham Lambert was the pioneer investment bank that developed the junk bond market.

The effects of the change in the tax regime were controversial. Scholes and Wolfson (1990) show that the passage of ERTA in 1981 stimulated reorganization activities, including LBOs. However, Schipper and Smith (1991) find that, although depreciation tax deductions arising from ERTA were generally positive for the firms that announced asset write-ups, they were not a significant source of gains in a number of management buyouts during the period 1982–1986. In the same vein as Schipper and Smith (1991), Kaplan (1989b) finds that while asset step-up elections had a positive value when made, they were not the driving force behind management buyouts.

The position of Holmstrom and Kaplan (2001) was not shared by many scholars, in particular by Bebchuk and Fried (2004) who asserted that senior management continues to dominate the corporate boards of most publicly held firms in the US and elsewhere. There is substantial evidence of this dominance, including excess CEO compensation, low sensitivity between CEO pay and performance, low sensitivity between CEO performance and turnover, low debt levels leading to unnecessarily large tax payments, minimal restrictions on senior managers’ sales or hedging of firm equity, and general support by boards for strong takeover defenses.

Metrick and Yasuda (2010) document that virtually all PE funds are set up as private limited partnerships with a ten-year term in which outside investors (e.g., banks, pension funds, insurance companies, etc.) act as passive limited partners and the PE firm is the controlling general partner. Limited partners have limited or no withdrawal rights prior to the expiration of the ten-year term. They are also potentially subject to additional capital calls by the PE general partner. Most PE firms use similar financing techniques in acquiring portfolio companies. The typical LBO is structured as a purchase of all of the publicly held stocks of a corporation by a privately held acquisition vehicle. A PE buyout firm generally controls this entity, with other types of buyers being much less common. The PE firm sponsoring the transaction will obtain its capital from the equity contributions of its buyout fund which, in turn, raises its capital from outside investors, and of the managers of the target firm plus the cash proceeds from privately placed loans secured by target firm assets and expected cash flows. As part of the acquisition, managers of the target firm obtain a significant equity interest in the firm. Normally, top managers in private-equity-owned firms have equity interests that are ten to twenty times larger than those held by their public company counterparts. After the acquisition, the general partners in the PE fund are actively involved in the strategic direction of the portfolio company.