Abstract

LBOs return to the public by issuing new equity in a reverse LBO. Since these companies were once publicly traded, they may suffer less from the information asymmetry plaguing regular IPOs and causing their underpricing. Prestigious underwriters may be able to signal firm quality to the market thereby possibly reducing underpricing. Previous research has found a significant negative relationship between prestige and underpricing in regular IPOs. It has been also determined that prestigious underwriters are associated with better operating firms. A recent study has found no such relationship between prestige and underpricing in reverse LBOs, possibly because they are less subject to information asymmetry problems. In this study, it is hypothesized that, since reverse LBOs have fewer information asymmetry problems, they may not need a prestigious underwriter to signal their quality, where quality is assessed by operating performance. Second, it is hypothesized that prestigious underwriters will associate themselves with quality firms in order to preserve their reputation. In a sample of two hundred reverse LBOs, operating performance is examined two years before and up to five years after the stock offering. Operating income and cash flow measures are used and adjusted for industry effects and mean-reversion problems. It is determined that firms may time their reverse LBO to coincide with their best performing year. Performance gradually decreases afterwards, but is still better than that of the industry. Using different proxies for prestige and different performance measurements mixed results are found. Sometimes a small and insignificant relationship is detected between performance and prestige which supports the first hypothesis. In other cases, a positive and significant relationship is detected, which supports the second hypothesis