The Influence of Corporate Governance on Managers’ Opportunistic Behaviours prior to Leveraged Buyouts in the UK

Abstract

This research investigates the influence of corporate governance mechanisms on managers’ opportunistic behaviours prior to leveraged buyouts (LBOs) in the UK. The UK is, after the US, the second largest LBO market in the world, where the total deal value of LBOs rose from £458.62 million in 1997 (the initial year of the sample period) to £817.12 million in 2011 (the end year of the sample period). This 15-year period covers a significant wave of LBO activity in the UK. This research extends previous studies of corporate governance and managerial opportunism by considering management leveraged buyouts (MBOs) and third-party LBOs separately, because managers’ incentives in each setting are different. Managers’ direct involvement in MBO transactions may lead to conflicts of interests between managers, who have an incentive to try to minimise the purchase price, and shareholders, who seek to maximise their selling price. In contrast, third-party LBOs are inherently more uncertain for managers’ long-term job security, which may serve to intensify managers’ incentives to engage in opportunistic activities to prevent takeovers.

This research comprises three empirical studies, which are structured to compare third-party LBOs with MBOs in relation to: the influence of managerial interests on takeover resistance and bid premiums (empirical study 1); the relationship between accounting conservatism and corporate governance (empirical study 2); and the influence of board structures and board effectiveness on takeover premiums (empirical study 3).

The first empirical study finds that managerial share options are negatively related to the likelihood of takeover resistance in third-party LBOs, possibly because managers can accrue high returns from exercising options immediately after the buyout. However, as expected, managerial share options and the likelihood of bid resistance are positively related in MBOs. The research also finds that high levels of managerial share options reduce the size of takeover premiums in both MBOs and third-party LBOs. The research suggests that while managerial ownership is positively associated with takeover resistance and bid premiums in third-party LBOs, these variables are not significantly related in MBOs.

The second empirical study finds that, during the year prior to the announcement of MBOs (year Y−1), managers engage in more conservative accounting, i.e. the asymmetric reporting of good and bad news, where bad news is disclosed faster than good news, possibly to reduce the perception of the firm’s value and thus depress their purchasing price. In order to identify the differences between accounting conservatism prior to MBOs and third-party LBOs, this study examines three years’ data preceding LBOs event. The research finds that managers engage in more conservative accounting in year Y−1 prior to MBOs than prior to third-party LBOs, but less conservative accounting in year Y−2. The research also finds a mean-reversion of managerial behaviours toward accounting conservatism precedes both types of LBOs. In particular, managerial behaviours shifted from less to more conservative prior to MBOs from year Y−2 to Y−1, but from more to less conservative preceding third-party LBOs from year Y−2 to Y−1 and year Y−3 to Y−1. In addition, this research suggests that the ownership characteristics and board characteristics have a greater impact on accounting conservatism in third-party LBO than in MBO firms.

The investigation of the relationship between board structures and takeover premiums in third-party LBOs and MBOs in the first empirical study suggested that board structures are not significantly related to takeover premiums in either case. However, the overall impact of the board on takeover premiums is not only determined by board structures but also by its effectiveness, which encapsulates directors’ qualifications, experiences, engagement, integrity and their ability to work together. Conflating board structures with its effectiveness can be misleading. Therefore, the third empirical study extends previous research on the effects of the board by investigating the impact of board structures and board effectiveness on takeover premiums in third-party LBOs and MBOs. In particular, during the analysis, this study takes into account the potential for moderating or mediating relationships between board structures and board effectiveness. Moreover, this research extends previous studies by employing the degree of accounting conservatism as a new measure of board effectiveness. The findings suggest that board size has a moderating effect on the relationship between board effectiveness and takeover premiums in MBOs such that the relationship is more positive when board size is smaller. Moreover, the research finds that board effectiveness moderates the relationship between CEO duality and takeover premiums in MBOs such that the relationship is more negative when there is a higher level of board effectiveness.