working papers

Security Design for Private Acquisitions (R&R RFS)

With Mark Jansen and Thomas Noe

Informal Abstract: Theoretical paper showing that if there is information asymmetry (the seller knows more about what he is selling) and optimism (the buyer thinks she will add value; they both agree on that but buyer thinks she will add more than what the seller thinks), then asking the seller to provide a loan to the buyer is a great idea. Much better than asking the seller to keep a stake in the company; even when the buyer is not financially constrained. However, if the buyer is too optimistic in her ability to add value, she will not ask for that loan, and will pay with cash only.

Formal Abstract: We propose a security design model in which a potential acquirer approaches a firm with a value-add plan. The target has a single owner, who possesses private information: he knows whether his firm is compatible with the plan, or not. The seller agrees the acquirer will add value but not as much as what the acquirer expects. Although the acquirer can choose any monotone limited liability security to offer along with cash, we show that, under general conditions, if a security is employed, it takes the form of non-recourse junior debt provided by the seller.

Capital Commitment

With Elise Gourier, and Mark M. Westerfield

Over ten trillion dollars are allocated to private market funds that require outside investors to commit to transferring capital on demand; most of these funds are Private Equity (PE). We show within a novel dynamic portfolio allocation model that ex-ante commitment has large effects on investors’ portfolios and welfare, and we quantify those effects. Investors are under-allocated to PE and are willing to pay a larger premium to adjust the quantity committed than to eliminate other frictions, like timing uncertainty and limited tradability. Perhaps counter-intuitively, commitment risk premiums increase with secondary market liquidity and they do not disappear even if investments are spread over many funds.

Employee Views of Leveraged Buy-Out Transactions

With Marie Lambert, Nicolas Moreno, Alexandre Scivoletto

A large sample of employee reviews shows a decline in satisfaction after a Leveraged Buy-Out (LBO), but with significant heterogeneity. The key driver is the previous ownership structure. For Private-to-Private transactions, dissatisfaction is concentrated in non-management employees and comes mostly from how management treats them. In Public-to-Private transactions, the dissatisfaction is stronger, multi-faceted, and present for all employees, including management. Industry and Private Equity sponsor fixed effects are significant, but second order. Other ownership changes (M&A, IPO) trigger less dissatisfaction.

Brexit & COVID-19 Death Rates

With Betty H.T. Wu

We uncover a striking relationship between the 2016 Brexit vote and COVID-19 death, infection, and vaccination rates in England. Districts that voted most heavily in favor of remaining in the European Union (top quintile) have a death rate that is one third lower, an infection rate that is a quarter lower, and a vaccination rate that is higher than Districts with the fewest Remainers (bottom quintile). The effect is stronger after the first wave, once protective measures are known and available. Our results suggest a need for designing incentive schemes that account for different cultures and belief systems. Science prowess – such as finding an effective vaccine – may not be sufficient to solve crises.

Data to replicate results are available here.

How Deadly Is Financial Leverage? Evidence from Care Homes during the COVID-19 Crisis

With Peter Morris and Betty H.T. Wu

Highly levered care homes have a death rate twice as high as unlevered care homes at the peak of the COVID-19 pandemic. Care homes controlled by private equity firms no longer display significantly higher death rates once controlling for leverage. Leverage matters only once accurately constructed: i) the full ownership structure of each care home needs to be identified; ii) operating leases must be capitalized and added to the balance sheet. These two issues have seldom been tackled in the literature and we show that they matter.

Thematic Investing With Big Data: The Case of Private Equity

Using natural language processing, companies globally can be scored based on the frequency with which news articles contain both their names and private equity (PE) related vocabulary. An index can then be created, with the weight of each component set as a function of both their liquidity and their PE exposure scores. This procedure generates a large set of firms whose underlying business is PE-related. Even though the algorithm does not optimize on either return or correlation, we find that the listed PE index is highly correlated to, and has similar performance to, the PE fund market index. This low-cost and scalable process can be generalized to any theme an index seeks to capture.