How CEOs’ Experience at Buyout Targets Affects Corporate Policies

Private equity (PE) firms influence their buyout targets in many ways. The literature documents that PE improves target firms’ operational practices, productivity, and innovation while cutting existing jobs and creating new ones. It is far less clear whether and how these PE-created effects extend beyond target firms. In a new paper, we examine the spillover effects of PE and investigate whether and how the prior work experience of public firm chief executive officers (CEOs) in PE buyout targets helps shape corporate policies and performance of these CEOs’ current firms.

Our study is, to the best of our knowledge, the first to show that the experiences managers gain during their work with PE sponsors can affect the corporate policies in their later roles as CEOs, i.e., what we refer to as the “managing with private equity style” effects. In addition, while finance research has studied the effect of CEO personal attributes on firm policies and performance, our paper is among the first to investigate the role of prior on-the-job training gained via repeated interactions with experienced finance advisors and monitors, i.e., PE sponsor firms.

There are several reasons why a CEO’s prior PE buyout-target experiences might matter. First, PE firms implement strong operating initiatives on their target firms, which leads to improved performance and increased economic value. In addition, existing literature also documents that PE targets have significantly better management practices than most other types of companies. Therefore, CEOs may find the managing style of PE beneficial and apply it to their current firms. Furthermore, PE firms usually take full control over their target firms, actively manage these targets, and subject CEOs of PE target firms to extremely high standards scrutiny. According to a recent Wall Street Journal article on CEOs of PE buyout target firms, “Executives can make their mark…by becoming the leader of a company owned by private-equity investors…Senior managers risk career derailment if they can’t handle the strict personal accountability, intense scrutiny and speedy decisions that private-equity firms often demand.” Therefore, the resulting intense work experiences in the PE buyout targets may leave a footprint on a CEO’s management style that may later be observed in the subsequent firms he or she is running.

Our paper uses hand collected data on CEOs of all U.S. public firms from 2000 to 2015. We track these CEOs’ employment history and identify whether the firms for which they previously worked have gone through leveraged buyouts (LBOs), management buyouts (MBOs), or going private transactions by PE firms. We identify 101 public firm CEOs who worked as CEOs for PE buyout targets firms. We find that public firms that hire those tend to cut more capital expenditures and employment, compared with the matched sample of firms that have similar characteristics but not CEOs with prior PE target experiences. These effects are economically significant: On average, the public firm CEOs with past PE target CEO experience reduce capital expenditures by 34 percent and cut employment by 23 percent within two years after taking office compared with the control firms with CEOs without prior PE target experience. We find similarly strong effects for longer time spans, up to five years after becoming the public firm’s CEO.

We conduct three further tests to better understand the underlying mechanisms of these findings and to mitigate the potential endogeneity issues. We find that the capital expenditure and employment cuts are more significant if the CEO (1) has more recent PE target work experiences, (2) worked at PE targets in which more reputable PE firms invested, and (3) worked at PE targets invested in by PE sponsors prone to cutting more investment or employment.

Finally, we examine the effects of hiring CEOs with past PE work experience on value creation. We find that firms with CEOs who previously assumed the CEO positions in PE buyout target firms (1) are more likely to file patents, (2) conduct more value-enhancing mergers and acquisitions, (3) use firm assets more efficiently (as evidenced by improved sales-to-asset ratio, and (4) ultimately manage to enhance firm value by increasing firm’s market-to-book ratio.

Overall, our findings are consistent with the view that PE investment has an impact beyond buyout targets. PE has spillover effects on public firms through the experiences public firm CEOs acquired when they previously served as CEOs in PE targets. These CEOs who were exposed to the principles of PE management (such as cost-cutting, focus on improved efficiency, enhanced innovation) during their work for the buyout targets appear to apply the same principles in their later roles.

This post comes to us from professors Scott Hsu and Tomas Jandik at the University of Arkansas’ Walton College of Business, and Juntai Lu, a PhD candidate at the school. It is based on their recent article, “Managing with Private Equity Style: CEOs’ Prior Buyout Target Experiences and Corporate Policies,” available here.

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