Corporate governance and firm performance of highly leveraged transactions: Evidence from leveraged recapitalizations and management buyouts

Abstract

We examine the effects of several corporate governance mechanisms on firm performance of two highly leveraged transactions (HLTs). Employing forty-one firms that implemented leveraged recapitalizations (LRs) and eighty-eight firms that undertook leveraged management buyouts (MBOs) during the period 1985-1990, we find that prior to their HLT, MBO firms tend to be smaller, be less profitable, have higher managerial ownership, have lower block ownership, and have a smaller fraction of independent outside directors on their board than LR firms. On the other hand, we observe no significant difference in board size or equity-based compensation between MBO and LR firms. Our regression results show that higher managerial ownership and greater equity-based compensation, which presumably help align managers' incentives with shareholders, are strongly associated with operating performance of MBO firms, but only marginally with operating performance of LR firms. In contrast, greater outside representation on corporate boards, which presumably improves shareholder monitoring, is strongly associated with operating performance of LR firms, but only marginally with operating performance of MBO firms. Blockholders' ownership, another effective mechanism of internal monitoring, is found to play a relatively insignificant role in enhancing operating performance of firms that go through a HLT. Our results are not attributed either to the difference in firm size or to an industry effect.