Lavery, Paul (2020) Essays on private equity buyouts. PhD thesis. http://theses.gla.ac.uk/82146/ Copyright and moral rights for this work are retained by the author A copy can be downloaded for personal non-commercial research or study, without prior permission or charge This work cannot be reproduced or quoted extensively from without first obtaining permission in writing from the author The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the author When referring to this work, full bibliographic details including the author, title, awarding institution and date of the thesis must be given Enlighten: Theses https://theses.gla.ac.uk/ [email protected] Essays on Private Equity Buyouts Paul Lavery Submitted in fulfilment of the requirements for the degree of Doctor of Philosophy Adam Smith Business School University of Glasgow October 2020 1 Abstract This thesis consists of three independent essays on the consequences of and market for private equity buyouts. The introduction provides a brief outline of the growth of buyout markets in recent decades and the conclusion summarises the main findings. The first essay examines the exporting behaviour of buyout target firms relative to control firms. We build a data set of over 1,400 buyouts in the UK from 2004 to 2017 and using a difference-in-differences approach, estimate the effect of private equity ownership on target firms’ exporting activities at the extensive and intensive margin, relative to a sample of carefully matched control firms. The results show that: (a) private equity ownership increases the probability of firms exporting (the extensive margin of trade); (b) private equity ownership increases the value of firms exports (the intensive margin of trade); (c) private equity ownership increases the exporting intensity of firms (the ratio of export sales-to-total sales). Our consequent findings indicate private equity investors' ability to alleviate financing constraints of companies, as our results are amplified where the target company is more likely to be in a constrained position. Along similar lines, target firms’ exporting is found to have been more resilient during the global financial crisis. To explain our find- ings, we postulate that improvements to target firms’ working capital management allows them to overcome the associated costs of exporting. Our results support this hypothesis: the working capital of buyout targets improves significantly relative to control firms. In an attempt to better understand how banking sector shocks can be transmitted onto the real economy, the second essay examines bank-affiliated private equity buy- outs and studies how portfolio companies respond to external shocks affecting their parent banks. In particular, we assess how the 2011 European Banking Authority (hereafter EBA) Capital Exercise impacted the portfolio companies of the private equity arms of affected and unaffected banks. Our results imply that the shock came with associated real effects: the portfolio companies associated with the pri- vate equity arms of affected banks experienced weaker investment and financing at the onset of the shock. These companies were consequently found to under-perform the portfolio companies of unaffected banks. The effects are heterogeneous in two ways: first, the negative effect on portfolio company performance is stronger for companies which were more likely to be constrained at the onset of the shock. Sec- ond, the effect is found to be stronger on portfolio companies whose private equity owner is less experienced. i The last essay investigates the importance of capital market development for inter- national buyout activity. Given the evidence of the diverse range of industry- and firm-level benefits of buyout investment, studying the stimulants of an active buyout market merits attention. Robust to a battery of checks, our findings strongly sug- gest that well-developed stock and credit markets are an important driver of buyout activity. We show that that capital market development is more important to buy- out investment relative to other types of international investment flows. Lastly, we underline the importance of countries' institutional environments for their buyout market activity. The positive effect of capital market development on buyout capital is significantly stronger in country-years with lower legal and political risk. ii Contents 1 Abstracti 2 Acknowledgements ix 3 Author's Declarationx 4 Introduction1 5 Chapter - Private equity buyouts & firm exporting5 5.1 Background................................5 5.2 Related Literature............................9 5.2.1 Private Equity Firms & Value-added..............9 5.2.2 Financial Frictions and International Trade........... 16 5.2.2.1 Theoretical Background................ 16 5.2.2.2 Empirical Evidence................... 17 5.2.2.3 Banks and Crises/Shocks............... 20 5.3 Hypothesis Development......................... 23 5.3.1 Private equity and exporting................... 23 5.3.2 The role of credit constraints.................. 24 5.3.3 Exporting during the financial crisis............... 26 5.3.4 Working capital.......................... 26 5.4 Data & Descriptive Statistics...................... 28 5.4.1 Sample construction....................... 28 5.4.2 Creating a matched control sample............... 35 5.5 Empirical model.............................. 41 5.5.1 Extensive margin of export.................... 41 5.5.2 Intensive margin of export and firm performance........ 42 5.5.3 Accounting for credit constraints................ 43 5.5.4 The working capital mechanism................. 43 5.6 Results................................... 44 5.6.1 Extensive Margin of Export................... 44 5.6.2 Intensive margin of Export.................... 48 5.6.3 Evolution of exports over PE buyouts.............. 50 5.6.4 Exporting, firm growth and financial constraints........ 52 5.6.5 Private equity, exporting & the crisis.............. 57 5.6.5.1 Data, descriptive statistics & model.......... 57 5.6.5.2 Empirical model & results............... 61 iii 5.6.6 Working capital mechanism................... 65 5.7 Robustness tests............................. 70 5.7.1 Pre-buyout growth patterns................... 70 5.7.2 Additional control variables................... 70 5.7.3 Attrition bias........................... 71 5.7.4 Alternative matching methodologies............... 71 5.8 Concluding Remarks........................... 75 6 Chapter - Bank-affiliated private equity buyouts and shocks to the banking sector 76 6.1 Background................................ 76 6.2 Literature Overview........................... 84 6.2.1 Banks and Private Equity (theoretical literature)....... 84 6.2.2 Bank-affiliated vs Independent(non-theoretical)........ 85 6.2.3 Bank shocks literature...................... 89 6.2.4 Impact of bank capital regulation on the real economy.... 90 6.3 2011 EBA Capital Exercise........................ 93 6.4 Hypothesis Development......................... 95 6.4.1 Portfolio company investment and financing.......... 95 6.4.2 Portfolio company growth.................... 95 6.4.3 Portfolio companies & financial constraints........... 96 6.4.4 Private equity investor experience................ 96 6.5 Data and Descriptive Statistics..................... 97 6.5.1 Data................................ 97 6.5.2 Descriptive Statistics....................... 99 6.6 Empirical methodology.......................... 103 6.6.1 Difference-in-difference approach................ 103 6.6.2 Empirical model......................... 109 6.7 Results................................... 110 6.7.1 Investment and financing policies................ 110 6.7.2 Company Performance...................... 115 6.7.3 Robustness............................ 120 6.8 Portfolio companies and financial constraints.............. 130 6.9 Private equity group reputation..................... 135 6.10 Concluding Remarks........................... 140 7 Chapter - The role of capital market development in international buyout markets 141 iv 7.1 Background & Hypotheses Development................ 148 7.1.1 Capital markets and buyout activity.............. 148 7.1.2 Business cycles and buyout activity............... 148 7.1.3 Institutional setting and buyout activity............ 149 7.2 Data & Descriptive Statistics...................... 152 7.3 Univariate Analysis............................ 159 7.4 Empirical Model............................. 163 7.5 Regression Analysis............................ 165 7.5.1 Role of capital market development for buyout capital invest- ment................................ 165 7.5.2 Buyout capital investment relative to other capital flows... 170 7.5.3 Accounting for the financial crisis and political environments. 172 7.6 Concluding Remarks........................... 177 8 Conclusion 178 References 180 v List of Tables 1 Deal time series distribution....................... 32 2 Sample statistics............................. 33 3 Sample statistics: transactions by PE investor............. 34 4 Descriptive Statistics........................... 38 5 Growth rates............................... 39 6 Extensive margin of exporting...................... 46 7 Extensive margin of exporting...................... 47 8 Intensive margin of exporting...................... 49 9 Evolution of exports over time...................... 51 10 Deal types................................. 54 11 Financial constraints: Size........................ 55 12 Financial constraints: