Management Buyouts: Boon Or Bane?

Abstract

In the present research a theoretical model of corporate divestitures is developed in which the wealth effects for divesting firms shareholders is examined for the case in which the acquirer is an incumbent management team and for the case when the acquirer is an outside buyer. Using an asymmetric information framework in which management enjoys specific utility from continued control of the operations, the model demonstrates that shareholders of the divesting firm should earn higher expected returns when the unit is sold to an incumbent management team rather than to an outside buyer. The subsequent empirical analysis reveals that this is in fact the case. While the announcement day ARs are statistically significant and positive for divestitures to both incumbent management teams and outside buyers, they are significantly larger when the buyer of the unit is the former. A similar and stronger results are observed for the 6 day period (t=-5 through 0) CARs. The policy implications of the theoretical model and empirical results reported above is that the divesting firms shareholders are not harmed, but receive higher returns when the units are purchased by an incumbent management team. Moreover, legislation to prevent or deter MBOs is not in the best interest of shareholders.