What is the Shareholder Wealth Impact of Target CEO Retention in Private Equity Deals?
There is considerable concern about the conflict of interest between the CEO and the shareholders when a firm is a target for an acquisition and the CEO is retained by the acquirer. The concern is that the CEO will bargain less forcefully to increase the premium received by shareholders. This concern is magnified with private equity buyout deals. With these deals, if the CEO is retained, she typically receives an ownership stake in the post-buyout company and, therefore, benefits directly from a lower premium paid to shareholders. In this paper, we examine whether target shareholders are hurt when the CEO in a private equity deal remains with the company as CEO following the buyout. We find no evidence that shareholders receive lower premiums when the CEO is retained in a private equity deal. In fact, we consistently find that, using different methodologies and different control variables, shareholders receive a higher premium when their CEO is retained in a private equity deal and that the additional gain of the shareholders amounts to 10 to 18 percent of the pre-acquisition firm value. This evidence differs from the existing evidence for acquisitions by public companies. When the CEO is retained by an acquirer that is a public company, the existing evidence shows that the shareholders are either not affected, or receive a lower premium.
We hypothesize that retention of the CEO by the acquirer can benefit shareholders of firms acquired in private equity deals in ways it does not in public acquirer deals. Specifically, in contrast to a public operating company with managers already in place to manage the acquired assets, a private equity firm has to put in place a team that will manage the acquired firm. All else equal, the private equity acquirer should value the target more if it expects that the target CEO will be better able to implement its strategy than other potential candidates and hence it should pay a higher premium. We call this hypothesis the valuable CEO hypothesis. Our findings support the valuable CEO hypothesis.
Our valuable CEO hypothesis predicts that a private equity acquirer pays more for a specific firm if the current CEO can the acquirer’s strategy more efficiently than other potential CEOs. We compare acquisition premiums for private equity deals when the CEO is retained to private equity deals for similar companies where the CEO is not retained. With this comparison, we find that acquisitions where the CEO is retained have higher premiums than acquisitions of similar firms where the CEO is not retained. We also investigate concerns that are often mentioned in the context of private equity acquisitions. First, we do not find that premiums are lower when the CEO is part of the buyout team. Second, we find that the valuable CEO hypothesis holds for club deals. Third, we find no evidence that CEOs attempt to lower the price of their firm ahead of a buyout. Finally, we find no evidence that bidders in private equity deals attempt to restrict competition.