Abstract

Jensen (1986, 1989) claims that LBO (Leveraged Buyout) process is a mechanism to decrease agency problems and improve efficiency in firms where managers' interests are not properly aligned with those of the corporation. Characteristics of LBOs such as high levels of financial leverage and management ownership of equity are thought to align the interests of owners and managers and lead to value maximization. Whereas other studies have limited their examination of the pre-IPO period to the year before the IPO, our study examines operating performance during the four years preceding the IPO. We document that during the last four years prior to their IPO, reverse LBO firms more than triple their operating performance relative to their same industry counterparts. Operating performance during the three years leading up to the IPO is shown to be positively associated with both high levels of financial leverage and management ownership of equity. Additionally, we find that reverse LBO underpricing is significantly negatively related to changes in operating performance occurring before the IPOs, to the length of time between the buyout and the IPO, and to the size of reverse LBO firms prior to their IPO. As well, we document a significantly positive relationship between underpricing and both the decrease in the leverage ratio at the time of the IPO and post-IPO stock price volatility. Finally, our study does not find an association between underpricing and managerial levels of equity ownership before or after the IPO