Financial leverance and its implications for business management : empirical evidence from Dutch management buy-outs

Financial leverance and its implications for business

management : empirical evidence from Dutch management

buy-outs

Citation for published version (APA):

Bruining, J., Herst, A. C. C., & Bonnet, M. P. B. (1998). Financial leverance and its implications for business management : empirical evidence from Dutch management buy-outs. (Publikaties Rotterdams Instituut voor Bedrijfseconomische Studies; Vol. 9845). Erasmus Universiteit Rotterdam.

Document status and date: Published: 01/01/1998

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FINANCIAL LEVERAGE AND ITS IMPLICATIONS FOR BUSINESS MANAGEMENT

Empirical Evidence from Dutch Management Buy~Outs

Hans Bruining (Erasmus University, P.O.Box 1738,3000 DR Rotterdam, Holland, tel. 3110 4081361, fax. 31 10 4526094, e-mail bruining@few.eur.nl) Arthur Herst (Maastricht University,P.O.Box 616, 6200 MD Maastricht, Holland,

tel. 31 43 3883838, fax. 3143258530, e-mail a.herst@bersin.ru.limburg.nl) Marcel Bonnet (Erasmus University, P.O.Box 1738,3000 DR Rotterdam, Holland,

tel. 31 10 4081323, fax. 31 10 4526280, e-mail bonnet@few.eur.nl)

Paper presented at the 1998 British Academy of Management Annual Conference, 14-16 September 1998, Nottingham, UK

ABSTRACT

In Holland Management Buy-Outs (MBOs) have become a popular instrument for corporate restructuring and transformation. Practice shows varying degrees to which financial leverage is applied in order to finance the MBO. The question we try to answer as to whether or not a substantially higher level financial leverage creates additional incentives or restrictions to take certain management decisions in order to improve economic performance of these MBOs. Is it an effective measure to create economic value or does it cause severe restrictions? Empirical literature to date does not give an unambigious answer as to whether an increase in financial leverage after an MBO is a curse or a blessing (Jensen 1986, 1989; Thompson and Wright, 1991). Therefore we concentrate on this issue and endeavour to find out what the impact of financial leverage is on business practices in Dutch MBOs.

We selected statements with regard to central issues in the buy-out literature: l)perceptions of the new owner/managers concerning the attention given to the short term performance, 2)business measures regarding optimizing cash flow, 3)re-organising efficiency of operations, 4)quantity and nature of investment and 5)investors' monitoring of the business operations. We compare levered MBOs having at least a 15 percent lower equity to total assets ratio than the industry average with other MBOs having a financial leverage in line with the industrial average, and verify if increasing levels of financial leverage enhance certain patterns of business measures or not. Our study reveals optimistic results on the subject of leverage in MBOs, but results are even more compelling when venture capital participation is considered. CEOs in leveraged MBOs clearly put more effort into maximising cash flow by taking significantly more frequent decisions to decrease working capital, to increase the use of production capacity, outsource supporting activities and to reduce overhead costs. Extra constraints on investment opportunities nor negative influences on the leveraged MBO firms' flexibility and capabilities to compete were found. Further analysis of the data yielded significant differences between venture capital and non venture capital backed buy-outs. CEOs of the former put higher demands on performance, pay more attention to cost control, are more mindful for growth opportunities and increase operating income by higher added value than the latter, thus signalling their stronger potential for growth. However, in the venture capital backed MBOs the levered and the other group of MBOs are equally represented.

1. INTRODUCTION

In some European countries, for example in Holland, Management Buy-Outs (MBOs) have become a popular instrument for corporate restructuring (Bonnet, et al., p.31) far more than the management buy-in, which for the UK is also a very important feature of corporate restructuring since the late 1980s (Robbie and Wright, 1996). An MBO involves members of the incumbent management team obtain a controlling interest in the company or subsidiary for which they are employed. If debt is used to finance the MBO transaction, the financial leverage of the company or subsidiary may rise above pre-MBO levels. Jensen argues that this increase forces management to make value optimizing decisions after a leveraged buy-out (LBO), especially in LBO firms with large cash flows and low growth prospects or in firms that must shrink (Jensen 1986, p. 324 and 1989, p. 65-67). However, according to Rappaport the increased debt burden may result in an insufficient free cash flow negatively influencing the firms' flexibility. Moreover, the small financial reserves limit the company's capabilities to compete (Rappaport 1990, p. 99). Reich (1989) also argues that the high level of debt associated with a leveraged buy-out forces firms to cut needed capital and R&D investments in order to service debt payments, thereby damaging their long-run efficiency and competitive position. Because empirical literature does not give an unambigious answer whether an increase in financial leverage after an MBO is a curse or a blessing, we try to answer in this paper the question whether or not an increase in financial leverage creates additional incentives or restrictions for the Dutch buy-out management to take certain management decisions.

We define business policy as the complex of management decisons aimed at optimizing the firm's market value in order to create acceptable levels of shareholder wealth. Between the US/uK and the Dutch MBO market there are some characteristic differences. First of all, the equity part in MBO financing is usually smaller in the US/uK than in Holland (Bruining 1992, p.22). Consequently, debt financing is more developed in the US/uK than in Holland. Capital protection law (the Civil Code art. 207c) forces participants in MBO-dealmaking to maintain acceptable levels of minimum net worth in order to protect the interests of existing shareholders and creditors. Secondly, most of the Dutch MBO deals are not financially but operationally driven, that means that entrepreneurial motives instead of personal wealth are dominant for management to opt for an MBO. In the third place, Dutch MBO firms are not as diversified in their business portfolio as their US counterparts. Therefore, we think it is interesting as to find out whether or not an increase in debt has the same impact on the implementation of management decisions in Dutch MBO firms as was found in studies for the US (e.g. Muscarella and Vetsuypens 1990, Palepu 1990, Easterwood e.o. 1989, Gibbs 1993, Ofek 1993) and for the UK (Thompson and Wright, 1991).

Our paper addresses the above issue as follows. Section 2 concentrates on the data used and the methodology applied. In Section 3 the empirical evidence is given. In Section 4 we summarize our main conclusions.

2. DATA AND METHODOLOGY

Because of practical applicability, in this research project we select the following definition of financial leverage: a levered MBO firm is a firm having a equity to total assets ratio that is more than 15% lower than the average equity to total assets ratio of the industry1. The equity to total assets ratio represents

IThis 15% is not arbitrarily choosen but based on a earlier study on Dutch MBOs of Bruining (1992). In his study of

a solvency ratio or 'the condition of ... [a] company in which obligations can be paid when due' (Helfert 1994, p. 498). In our project the industry average serves as the benchmark; its solvency or equity/total assets ratio is considered to be the optimal ratio. This procedure is supported by the practice of Dutch banks and venture capitalists (see for example 'Solvency in balance' published by the Dutch 'Nationale Investeringsbank' in 1990). When providing unsecured loans to firms, these financial institutions usually require the borrower to raise their equity to total assets ratio to the average level of the industry within two to four years.

In 1995 we sent a questionnaire to managers of 200 firms who realized their MBO 2 in the period 1987-1992. About 25 percent returned useable questionnaires. 72% of the managers having returned the questionnaire bought a subsidiary from a parent company, the remaining 28% bought an (family-owned) independent firm. In order to get a description about how the equity to total assets ratio developed before and after the transaction, we requested each manager to supply information about equity and total assets on a period starting 2 years before his MBO and ending 5 years after the transaction. We formed a group of 28 levered MBO firms of which the equity to total assets ratio of each company is at least 15% lower than the industry average at the time of the transaction, and a group of 24 other MBO firms. The equity to total assets ratios of these other firms are more in line with industry averages (Le. each of these other firms have a ratio that is less than 15% lower than the average ratio of the industry). See Appendix I. The Wilcoxon Rank Sum W Test proved the statiscally correctness of this split between the two groups of MBO firms. During the first two years before the buy-out there were no significant differences in equity to total assets ratios, as opposed to the period after the transaction (2-Tailed P values: year 0= .0000; year 1= .0032: year 2=.04: and year 3=.05). Consistent with Figure 1 these significant differences dissappear in year 4 and 5, because management reduced debt to more acceptable levels comparable with their industry.

After screening the international buy-out literature we selected the following statements, representing five groups of questions, describing different consequences of the conceptual relationship between financial leverage and business policy after an MBO:

1. the new owners of the firm pay more attention to its short-term performance,

2. the new owners maximize the company's cash flows by increasing productivity, by decreasing working capital and by taking risk reducing measures,

3. the new owners increase the firm's liquidity by selling redundant assets and reorganizing inefficient operations,

4. the new owners reduce investments and limit the development of growth strategies such as acquiring other firms,

5. banks, venture capitalists, private investors and other external investors monitor business policy more closely.

On a 5 point Likert-scale the perceptions of the buy-out managers were measured in order to see as whether or not the new owners of the levered MBO firms put higher demands after the buy-out than the managers/owners of the other group of firms.

The first group of questions regards the attention paid to economic performances on the short term, on

solvency than the industries.

20ne might object that the questionnaires give a biased picture of the Dutch MBO scene, because only managers of successful firms would respond. However, most Dutch MBOs are successful; in Holland a mere 4% of the firms bought by their managers goes bankrupt.

cost control and on growth opportunities. The second group of questions relates to the importance of business measures intended to maximize cash flows taken after the MBO and how important they are for the development of economic performance, such as strict cost control, efficiency improvement by investments, increasing labour productivity and production capacity. More specific questions were asked whether or not more attention had been paid to items such as reduction of purchase prices, of wages, of overhead-costs, of expenses on research and development, of the marketing expenses and flexibilization of labour. The third group of questions relates more to restructuring such as dismissal of employees, closing down of sites, rationalisation of production capacity, termination of insufficiently profitable (or loss-generating) turnover and outsourcing of supporting activities. The fourth group of questions refers to questions regarding growth, increase of margins and value by a change in the product- or serviceline, introducing fundamentally new products/services, but also efforts put into new users, expanding the range of products, geographic expansion and acquisitions of suppliers or competitors with higher added value products/services than their own. Finally we asked these CEOs about the frequency with which financial information about results and operations was supplied to external investors; whether these attached more value to the long term than the short term economic performance of the MBO firm, participated more intensively in generating strategy proposals, in the choice of strategy and its implementation and judged the buy-out managers more critically than before theMBO.

With the Wilcoxon-Mann-Whitney Test (a non-parametric statistical test) we calculated the p-values, indicating the associative relationships between financial leverage and management decisions as described above. As the nill hypothesis we formulated that management decisions are independent of the degree of financial leverage.

3. EMPIRICAL EVIDENCE

Figure 1 in Appendix I shows the development of the equity to total assets ratios of both groups of companies (source: questionnaires) and the development ofthe average solvency ratio ofthe industry (source: Amsterdamse Investeringsbank). Compared to the industry averages the levered MBO firms show substantially lower equity to total assets ratios than the other group of MBO firms in the year of the transaction. This 19.1 percent deterioration in solvency however, is recovered by the management of these firms in approximately 4 to 5 years.

With respect to the five groups of questions in this paper we found the following evidence:

ad 1. Because of the fact that management has become (co )owner of the company after the MBO the CEOs were asked for their opinion about the statements below (see Table 1). From the descriptive statistics in this table it shows that a majority (varying between 60 to 75 %) of the CEOs in our sample are putting higher demands after the MBO on performance, paying more attention to cost control and are more mindful for growth opportunities. With the Mean Rank Test we did not find any significant differences between the two groups. In other words the nill-hypothesis was accepted here. There were no significant differences between both groups with regard to CEOs opinions about intensified performance control. However, the facts about the implementation of their management decisions in levered MBOs, which we will describe in the rest of this paper, are in some respects in contrast to these perceptions.

Table 1: Statement to the directors of MBO firms (levered and other)

% of Sample

Fully Fully Sample Mean Median STD

Agree Disagree size

1 2 3 4 5

management demands higher performances 32.7 26.5 28.6 12.2 0.0 49 2.2 2.0 1.04

puts more emphasis on cost control 38.8 34.7 14.3 12.2 0.0 49 2.0 2.0 1.02

is more mindful for growth opportunities 25.0 39.6 25.0 8.3 2.1 48 2.2 2.0 1.00

management pays more attention to the

development of performance 42.9 36.7 10.2 6.1 4.1 49 1.9 2.0 1.07

there is more cohesion among management

about the business policy 27.1 29.2 33.3 8.3 2.1 48 2.3 2.0 1.03

decisionmaking goes quicker 60.9 19.6 6.5 8.7 4.3 46 1.8 1.0 1.18

business policy is more effective 43.5 32.6 13.0 6.5 4.3 46 2.0 2.0 1.12

An interesting exception to this general finding was found when we divided the sample in MBOs with and without venture capital participation. CEOs of MBOs with venture capital participation show practically on all the opinions from Table 1 a systematically higher level of scores than the MBOs without venture capital participation. To sum up they say they put more frequent higher demands on performance (p=.06), significantly more frequent emphasis on cost control (p=.03), pay more attention to performance development (p=.02), show more cohesion among management about business policy after the MBO (p=.008) and report frequently perceptions about quicker decisionmaking (p=.02) and more effective business policy as compared to before the buy-out (p=.02). Interestingly to note is that the group MBOs with venture capital participation is equally represented in both groups (35 percent of the levered and 35 percent of the other group). Apparently venture capital involvement is a decisive factor with respect to CEOs opinions.

ad 2. Another set of questions concerns the importance of some recurring management decisions after

MBO for the development of a better operating income (see Table 2). The entrepreneurs/CEOs were asked to score eight factors which may commonly be used to develop operating income to optimal levels, on a scale from five, being 'very important', to one, being 'not important' .

Compared to the group with levels of equity to total assets more in line with the industry average, the levered group attaches significantly more importance to factors which increase operating income, such as increasing use of production capacity (p=.03), outsourcing supporting activities (p=.04) and taking more often outsourcing decisions in 'make or buy' situations (p=.06).

If we compare MBOs with and without venture capital participation then the management decisions to improve efficiency by investments are significantly frequent taken by the former (p=.04). This does also hold for making alliances in the field of R&D, for purchase and marketing (p=.03), for decisions to increase margins and! or value added (p=.03) and for operating income levels.We think that growth oriented business measures dominate in this group of MBOs, because strong p-values were found indicating that these MBOs already were better performing before the buy-out than the other group. After the transaction they maintain systematically higher operating income level as compared to the

groups without venture capitale participation.

Table 2: Favourable factors to increase operating income

% ofSampJe

Not Very Sample Mean Median STD

Important Important size

1 2 3 4 5

strict cost control 6.4 2.1 19.1 40.4 31.9 47 3.9 4.0 1.09

efficiency-improvement by investments 11.9 11.9 26.2 40.5 9.5 42 3.2 3.5 I.lO

increasing labour-productivity 2.2 8.7 34.8 41.3 13.0 46 3.5 4.0 0.91

increasing use of production capacity 10.3 12.8 23.1 51.3 2.6 39 3.2 4.0 1.06

outsourcing supporting activities 28.2 25.6 23.1 20.5 2.6 39 2.4 2.0 1.19

outsourcing in case of make-or buy decisions 32.4 24.3 18.9 16.2 8.1 37 2.4 2.0 1.32

cooperating/alliances (R&D, purchase, market.) 21.6 27.0 21.6 24.3 5.4 37 2.7 3.0 1.23

increasing margins and/or value added 9.5 9.5 26.2 47.6 7.1 42 3.3 4.0 1.07

However to our surprise, in taking a closer look to the selected decisions which increase margin andlor value added (see Table 3), no significant differences remained for the buy-outs with

vel

participation no participation levered non-levered

n=25 n=23 n=25 n=21

yes no yes no yes no yes no

a change in the product- or serviceline 64% 36% 61% 39% 56% 44% 76% 24%

termination of insufficiently profitable

(or loss-generating) turnover 64% 36% 57% 43% 56% 44% 71% 29%

positioning in the high price/service/quality

segments of the market 60% 40% 70% 30% 64% 36% 67% 33%

introducing fundamentally new products/services 40% 60% 39% 61% 36% 64% 38% 62%

taking over competitors who sell products with a higher value added then the company's

own products 12% 88% 4% 96% 8% 92% 14% 86%

taking over suppliers and/or clients 4% 96% 4% 96% 8% 92% 5% 95%

A majority of the MBO-groups takes decisions to effect changes in product or serviceline, to terminate insufficient profitable turnover and tries to position itself in the high price/service quality segments of the market. Probably we have to improve the way we handled the issue of value added in our

questionnaire. However, interestingly no MBO firm in our sample played the role of a locomotive to build up potential through acquisitions of compititors and suppliers. Growth is reached autonomously

and not by external growth. This conclusion is in line with the findings of the turnover factors we will present in Table 7.

Regarding decisions to control cost after the MBO we asked the CEOs if they did choose measures from Table 4. Despite much effort of both groups to reduce overhead costs in order to increase operating income, the levered MBO firms in our sample appear to take more frequently the business decision to reduce overhead costs (p=.06) than the other MBOs.

Table 4: factors for cost control

participation no participation levered non-levered

n=26 n=22 n=24 n=22

yes no yes no yes no yes no

reduction of prices of purchased materials 65% 35% 54% 46% 63% 37% 59% 41%

reduction of wages 19% 81% 0% 100% 8% 92% 13% 87%

reduction of overhead-costs 77% 23% 77% 23% 88% 12% 64% 36%

reduction of expenses on RD 4% 96% 5% 95% 8% 92% 0% 100%

reduction of marketing expenses 4% 96% 9% 91% 9% 91% 5% 95%

increasing flexibility of labour (temporary

contracts, flexible working hours) 46% 54% 42% 58% 41% 59% 47% 53%

relating rewards to performances 42% 58% 36% 64% 38% 62% 40% 60%

limitation range of products 15% 85% 27% 73% 17% 83% 27% 73%

Decisions to reduce wages and expenses on R&D and marketing are hardly taken to control costs in the four distinctive groups of MBO firms. Approximately four out of ten MBO firms of each group take decisons to increase flexibility of labour and implement a reward structure related to performance. The next group of questions for the CEOs try to measure how important the respective management decisions are for the amount invested in working capital (see Table 5).

Table 5: factors of influence on working capital

% of Sample

Not Very Sample Mean Median SID

Important Important size

1 2 3 4 5

reducing the size of stock of materials 19.4 13.9 27.8 27.8 11.1 36 3.0 3.0 1.30

reducing the size of stock of products 21.6 16.2 18.9 29.7 13.5 37 3.0 3.0 1.38

speeding up the production process 22.9 14.3 25.7 28.6 8.6 35 2.86 3.0 1.31

paying creditors later 18.9 21.6 35.1 21.6 2.7 37 2.68 3.0 1.11

making debtors pay sooner 5.1 7.7 35.9 30.8 20.5 39 3.54 4.0 1.07

The first four factors in this table with a median score of 3 on a 5-point scale have some influence on optimizing working capital of all MBOs in our sample. In order to minimize the amount invested in working capital the other group ofMBOs pay their creditors later than the levered group (p=.03). We expected this to the case for the levered group but not for the lower levered group. Moreover we asked for each consecutive 2 years before and 5 years after the MBO which amount of money was invested in net working capital. The levered group had significant higher levels (two years before: p=.05; and one year before the MBO: p=.03) of working capital than the other group of MBO firms, but this difference disappeared after the MBO. This cost reducing effort is evidence for cash flow optimising activity.

In line with the higher income levels of MBOs with venture capital involvement, was the finding that these MBOs appear to have systematic higher levels of working capital after the MBO during five consecutive years than the group without venture capital. P-values are reasonably strong for every year and vary between .07 and .005. Probably the costs of higher levels of working capital are justified by higher economic activity in these companies (see Table 2).

ad. 3 In order to reduce cost level only once, two factors seem to be important in the eyes of the MBO-entrepreneurs (see Table 6): dismissal of personnel and rationalising production capacity (more than 1 answer possible). Nearly half of the sample (n=46) however admits that dismissal takes place only once, in order to get an acceptable costlevel, whereas 52 percent put effort in rationalising production capacity to reach the same goal. Our statistical test shows no significant differences between the distinctive groups, nor from the angle of financial leverage, nor from the angle of venture capital participation.

Table 6: Non-recurring factors to reduce costlevel (n=46)

Choosen Not Choosen

rationaIising production capacity 52% 48%

dismissal of personal 46% 54%

closing down/seIling certain activities 26% 74%

closure of sites 20% 80%

However not significant, managers of levered MBO firms make more frequently radical arrangements to improve their firm's liquidity e.g. they stop more frequently unprofitable activities andlor product lines (p=.09).

ad. 4 With regard to investment and growth, we asked the CEOs in the case that the development of turnover after the MBO is more favourable than before the MBO, which of the following factors they consider of importance to this growth? And to what extent? They were asked to score seven factors which may commonly be used to evaluate the increase or decrease of turnover, on a scale from five, being 'very important', to one, being 'not important', as well as not applicable. All first five factors are taken into account in some way, though there are marked variations in their relative importance (see Table 7). The most notable factors in order of importance were better market share through marketing/sales efforts, new users reached, and expanding range of products with new/other products.

The levered group achieved improved marketshare through marketing/sales efforts more often than the other MBOs (p=.04).

The remaining factors had all scores below three, suggesting that they were not particularly important to explain the favourable development of turnover after the MBO. Expansion through acquisitions in related or unrelated industries, although very entrepreneurial in nature, are unimportant factors to explain the increase in sales after MBO. It confirms our opinion that sales growth is reached autonomously and not by external growth. This is in line with the findings represented by the last two items from Table 3.

Table 7: Favourable turnover factors

% of Sample

Not Very Sample Mean Median STD

Important Important size

1 2 3 4 5

higher growth of sales markets 11.8 29.4 23.5 23.5 11.8 34 2.94 3.0 1.23

better market share through marketing/sales

efforts 0.0 5.1 28.2 48.7 17.9 39 3.80 4.0 0.80

new users reached 7.7 2.6 25.6 48.7 15.4 39 3.62 4.0 1.04

geographic expansion/intemationalisation 32.4 10.8 18.9 27.0 10.8 37 2.73 3.0 1.45

expanding range of products with new/other

products 10.5 15.8 21.1 34.2 18.4 38 3.34 4.0 1.26

expansion through taking over competitors 71.4 14.3 2.9 8.6 2.9 35 1.57 1.0 1.09

expansion by taking over in other branches 85.3 5.9 2.9 0.0 5.9 34 1.35 1.0 1.01

If we look at the character of favourable turnover factors in Table 7 and the nature of the investments in Table 8, we do not find evidence that CEOs of Dutch levered MBO firms limit the development of strategies aimed at future growth or reduce investments more than the other firms in the sample. On the contrary more than 90 % of both groups do not take decisions to reduce marketing nor R&D expenses (see Table 4). Calculations of the average investment level of both groups show only a decrease one year before the transaction. After the MBO on a 95 percent of confidence basis we observe over a 5 year period that average investment levels significantly increase for all MBOs (see Appendix 2). From the nature of investments in Table 8 we observe that the replacement and modernisation in more than 75 percent of the cases comes first in the years following directly after the buy-out, whereas 34 percent of the sample invests in expansion in the second and third year after the MBO, an increase of 25 percent which seems to stabilise in the 4th and 5th year. The general finding (see Table 3) that sales growth is reached autonomously and not by external growth, is again consistent with the findings in Table 7. Both groups of MBOs succeeded in managing growth internally instead of externally by taking over other frims. This is an important finding sustaining the efficiency and restructuring argument as an explanation for the increased economic performance after the MBO.

From the four distinctive groups the venture capital led MBOs show, during a period of four years after transaction, a systematic higher level of investment after the MBO than the group without venture capital involvement, whereas this is not the case before the MBO (p-values vary from .004 to .04).

Table 8: Nature of investments (n =47).

1st year 2nd+3d 4th+5th

afterMBO year year

afterMBO afterMBO

replacement and modernisation 72% 77% 55%

expansion-investments 13% 36% 34%

taking over companies 4% 6% 6%

ad. 5 We asked the CEOs to compare the stockholders' participation in the MBO firm with the parent company or former stockholders in the matter of supervision and influence in the firm. In the eyes of the CEOs the external stockholders of levered MBOs such as banks, venture capitalists and private investors do not monitor business policy more closely than the external stockholders of the other MBO firms.

Table 9: Supervision and influence of stockholders (n=36)

want to be informed about financial results more often want to be more informed about the operation of the company

attach more value to long term performances instead of short term (1 yr) participate more intensively in generating company policy proposals have a greater influence on the choice of company policy proposals are more involved in executing company policy

judge management results/performances more critically

% of Sample YES NO 55.6 44.4 58.3 41.7 65.7 34.3 54.3 45.7 55.6 44.4 61.1 38.9 57.1 42.9

As we expected, external investors of the buy-out firms with financial leverage levels in line with the industries set significantly frequent higher priorities for long term performance instead of short run performance (p=.Ol) as compared to the levered group, indicating that the last group ofMBOs places also considerable importance to the performance in the short term.

Regarding questions of supervision and control by the new stockholders as compared to the situation before the MBO, for MBO firms with venture capital participation in comparison with MBOs without venture capital participation, it is obvious that our test showed a significant different pattern of answers. Compared to the situation before the buy-out, CEOs of the venture capital backed MBOs give the new stockholders systematically more information about the operation of the company (p=.03) than the group without VCI involvement. The latter has no formal representatives of the venture capital firm in the supervisory board but e.g. former directors or independent others. Supervision and influence in the eyes of these CEO remained more or less unchanged for this group of MBOs. Besides more information about the management of operations, the new stockholders of the venture capital backed

MBOs do participate more intensively in generating company policy proposals (p=.007) and have greater influence on the choice between company policy proposals (p=.005). Moreover, they attach more value to long term performance instead of 1 year performance (p=.02), a feature which they share with the non-levered group. This may reflect the scarcity of typical high leveraged buy-out deals in The Netherlands during the late eighties and early nineties, and thus the relatively longer presence as shareholder in buy-out firms necessary to increase economic value through the years as compared to the buy-outs in the UK and the US.

4. CONCLUSIONS

In this paper we sought to answer the question as to whether or not levered MBO firms compared to substantial lower levered group of MBOs show differences in frequency and relative importance of several business measures in order to attune company policy to the realization of the company objectives. A majority of the CEOs of the levered MBO firms and of the non-levered MBO firms take more intensively care of performance as compared to the situation before the MBO. There were no significant differences between both groups with regard to CEOs opinions about intensified performance control. With regard to opinions about intensified performance control, our study shows no significant differences between both groups. Yet managers in levered MBOs clearly put more effort in maximising cash flow by taking significantly more frequent decisions to optimize working capital during the MBO preparations, to increase the use of production capacity, to outsource supporting activities, to take 'make and buy decisions', to reduce overhead and attach more importance to short term performance. The cash flows from these economizing actions are used clearly to payoff debt (see Appendix 1). No differences were found in terms of dismissals, closing downs, selling certain activities, rationalising production capacity, investment level and with regard to monitoring buy-out operations. However not significant, levered MBOs aim more frequently to stop unprofitable activities. We did not find any prove of negative influences on the levered MBO firms' flexibility or on its capabilities to compete, instead they improve marketshare, intensify marketing and sales efforts and do not reduce R&D and marketing expenses. Extra constraints on investment opportunities were not found. On the contrary, aver~ge investment level rises for both groups of MBO firms. Therefore, we can not sustain the view of Rappaport and Reich for these Dutch MBO firms that the increased debt burden will hamper the levered fum to maximize its market value.

By dividing the sample into MBOs with and without venture capital participation, analysis of the data yielded other significant differences. CEOs of venture capital backed firms put significantly higher demands on performance, pay more attention to cost control and are more mindful for growth opportunities as compared to the non venture capital backed group of CEOs. They realise significantly more often efficiency improvements by investments, increasing margins to enhance operating income and report substantial higher levels of working capital after the MBO. Also these firms show a systematically higher level of investment after the MBO, signalling their stronger potential for growth. Obviously these CEOs inform their stockholders more often about the operations of the firm, using their participation more intensively in generating and selecting company proposals. This reflects strongly the changes which took place in the governance structure after the buy-out, whereas this remained more or less unchanged for the non-venture capital backed MBO firms.

Our study reveals optimistic results on the subject of leverage, but the results are even more compelling when venture capital participation is considered. Fruitful areas of further research are suggested by our

findings including the question as to what extent venture capitalists contribute to the economic performance of the MBO firms.

On the basis of this research we conclude for the moment that, irrespective of the extent of financial leverage, venture capitalists not only select the best performers among the MBO firms, but also succeed in stimulating cohesion among and motivation of the management team to pay more attention to control performance in the short and long run.

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Bruining, J., Performance Improvement After Management Buy-Out, Phd. Erasmus University Rotterdam. 1992

Easterwood, J.C .• A. Seth en R.E Singer. The Impact of Leveraged Buyouts on Strategic Direction, California Management Review, 1989.

Gibbs, P.A., Determinants of Corporate Restructuring: The Relative Importance of Corporate Governance, Takeover Threat and Free Cash Flow, Strategic Management Journal, Vo1.14. 1993.

Helfert, E.A. Techniques of financial analysis. Burr Ridge (lllinois): Irwin, 1994.

Jensen, M.C., Agency Costs of Free Cash Flow, Corporate Finance and Takeovers. American Economic Review, 1986. Jensen, M.C., Eclipse of the Public Corporation. Harvard Business Review, 1989.

Muscarella, CoJ. and M.R Vetsuypens. Efficiency and Organizational Structure: A Study of Reverse LBOs, The Journal of Finance. Vol XLV No 5,1990.

Nationale InvesteringsBank, • Solvency in balance'. The Hague (Holland): Nationale InvesteringsBank, 1990. Ofek. E .• Capital structure and firm response to poor performance, Journal of Financial Economics 34, 1993. Palepu, K.G., Consequences of leveraged buyouts, Journal of Financial Economics 27, 1990.

Rappaport, A., The Staying Power of the Public Corporation. Harvard Business Review, JanlFeb 1990. Reich, RB. Leveraged buyouts: America pays the price. New York Times Magazine, Jan 29.1989.

Robbie, K. and M. Wright, Management Buy-Ins- Entrepreneurship. Active Investors and Corporate Restructuring. 1996 Thompson, RS., M. Wright. UK Management Buy-Outs: Debt, Equity and Agency Cost Implications, Managerial and decision Economics, 1991.

Appendix I: DEVELOPMENT OF EQUITY !fOT AL ASSET RATIOS OF LEVERED MBOs AND OTHER MBOs COMPARED TO THEIR lNDUSTRY AVERAGES

50 ... ..

...

.. ..-.() ... - ..

.,.-'

····0····

() Levered MBOs (n=28)

10~----~----~----~----~----~----,---~ Industry Levered MBOs (n=28)

·2 -1

o

Bookyears after MBO

3 4 5

Appendix 2: INVESTMENT AS A PERCENTAGE OF SALES (2 years before and 5 years after the MBO;n=46)

t-2 t-! HI H2 H3 t+4 t+5

average 3.32 2.83 3.71 4.75 4.91 4.29 5.03