John C. Easterwood

The Role of Private and Public Debt in Corporate Capital Structures

This paper examines the extent of reliance on private debt from 1980 through 1988 for a set of firms selected from Fortune 500 firms in 1980. The average firm in this set obtained more than half of its debt from private sources throughout the period, with a slight decline in the mid-1980s. Cross-sectional analysis reveals that a firms reliance on private markets for debt financing is negatively related to the amount of outstanding long-term debt. Use of private debt is not linked to standard proxies for the potential for leverage-related costs for this group of firms.

The Impact of Leveraged Buyouts on Strategic Direction

This article examines the leveraged buyout as a tool for corporate restructuring and focuses on the strategic impact of leveraged buyouts on a firmss corporate objectives. The article documents the increased frequency and size of large leveraged buyouts over the period of 1978-1985. A leveraged buyout brings about four changes in the firm: changes in ownership structure, changes in capital structure, changes in asset structure, and changes in organizational structure. The changes in ownership structure involve significant increases in the stakes of managers and large holdings by the buyout specialists fund. In addition, leveraged buyouts are accompanied by a large increase in debt financing. These changes in ownership and capital structure influence the strategic decisions made by the post-buyout firm. In the post-buyout firm, asset acquisition and divestment decisions and organization structure changes are aimed towards creating shareholder value and maintaining debt coverage.

CONTROLLING THE CONFLICT OF INTEREST IN MANAGEMENT BUYOUTS

A controversial aspect of the management buyouts that were popular throughout the 1980s is the potential for a conflict of interest to arise when a manager bids to acquire the firm he manages. This study examines 184 management buyouts and reports three findings. First, returns to prebuyout shareholders are greater when managers must bid against outside acquirers. Second, bid revisions in the face of competition exceed revisions due to shareholder litigation and negotiations with boards. Third, the incidence of competition is negatively related to the prebuyout share holdings of managers. Coauthors are Ronald F. Singer, Anju Seth, and Darla F. Lang. Copyright 1994 by MIT Press.

Bondholder Wealth Effects of Management Buyouts

We study the impact of 29 management buyouts (MBOs) announced during the years 1981-1989 on the value of the firms outstanding nonconvertible bonds. Using two methodologies-market-adjusted retums and mean-adjusted returns we provide evidence confirming the presence of significant bondholder wealth losses of about 3% associated with the announcement of MBOs. This evidence is in conflict with that provided by Marais, Schipper, and Smith, but is consistent with the results of the recent studies by Asquith and Wizman, and Warga and Welch. The magnitude of the losses in our study is similar to that reported by Asquith and Wizman. For example, the set of our firms which contained no dividend and leverage restrictions experienced an average loss of 6.5%, whereas, for a similar partition, Asquith and Wizman reported an average loss of 5.2%. Our findings are not sensitive to the choice of methodology employed. Furthermore, our findings indicate that bond price reactions are sensitive to the presence of restrictive covenants and maturity.

Wealth Effects of Corporate Debt Issues: The Impact of Issuer Motivations

This study documents a link between the markets reaction to a new issue announcement and the issuers motivation for both debt and equity issues. Negative and significant price reactions occur for outstanding debt and equity when the issuer faces an unexpected cash flow shortfall. Insignificant reactions accompany unexpected increases in capital expenditures or leverage or an expected debt refinancing.

New Evidence on Serial Correlation in Analyst Forecast Errors

Securities analysts react optimistically to new information, underreacting to bad news and overreacting to good news. This evidence suggests that securities analysts might produce optimistic earnings forecasts in response to their economic incentives.

Limits on managerial discretion in management buyouts: the effectiveness of institutional, market and legal mechanisms

Recent changes in the legal environment faced by US corporations suggest that the shareholder-manager conflict of interest, and the effectiveness of mechanisms to narrow this divergence, are issues of continuing importance. This study examines the linkages between institutional, market and legal mechanisms to control managerial discretion in management buyouts, and the circumstances under which each type of mechanism is effective. We find that these mechanisms do act to control managerial discretion in management buyouts to some degree. At the same time, there appear to be significant frictions which act to partially insulate managers from these types of governance, limiting their effectiveness.

Benefits and Costs of Asset Reallocation in Mergers and Acquisitions

The Q-theory of mergers and acquisitions proposes that takeovers of low-Q targets by high-Q acquirers should be value creating as acquirers redeploy the targets’ assets. Recent evidence on the direct relationship between Q and value creation is mixed. We present a simple model which suggests three modifications to the standard empirical approach. First, we allow for both benefits and costs of integration that are likely to accompany asset reallocation in M&As. Second, we use a modified proxy for the Q ratio in our empirical tests after decomposing the market-to-book ratio – the conventional proxy for Q – into its long-run and short-run components. Third, our model suggests that the correct regression specification requires the weighting of proxies for the benefits and costs of asset reallocation by the relative size of the resources being reallocated. After the modifications, we find evidence consistent with Q-theory using announcement returns and operating performance as alternative measures of value creation. The relation between value creation and Q-difference is inverse U-shaped, indicating a tradeoff between benefits and costs of asset reallocation. We also find that the long- and short-run components of Q relate significantly differently to value creation in M&As.