Why do firms use private equity?

Speaking at a Yale finance and accounting seminar later today, Amy Dittmar from the University of Michigan asks a very pertinent question: Why do firms use private equity to opt out of public markets? (PDF).

Written with co-author Sreedhar T. Bharath, their paper employs a comprehensive sample of going private transactions from 1980-2004 in the US. Their model does a remarkably good job of predicting which public firms will go private:

Using only data at the time of the IPO, we are able to correctly predict who will go private 80.6% of the time. This result implies that it is not only the path that the firm takes but factors inherent and observable about the firm at the time of going public that determines if it eventually will go private.

And what is driving those decisions? They accord well with theory:

Our results provide strong support for the importance of information and liquidity considerations in being a public firm. Access to capital and control considerations become increasingly important over the public life of the firm. We also find that the information and liquidity factors that drive the firms to go private are evident at the initial public offering, on average thirteen years before the going private decision.

A nice piece of research.

Comments

[claus vistesen]

Whatever would we do if you weren't here to filter the massive flow of econresearch for us :) ...

Another excellent find, thanks.

Methinks, I will take this to my corporate finance class alongside that other piece on securitisation in the US. They should stir up some nice discussions I think.

Claus

[Lafayette]

cv: "Another excellent find, thanks."

I wonder. It doesn't correlate with my observation of the how and why private equity capital (PEC) works.

Much of PEC (in Europe) is employed to purchase long-standing companies who have fallen on bad-times by mismanagement.

What the target company needs is strong, talented leadership to clean up the mess and put it back on the right track. Once it starts generating profits the PEC firms sell it and reap their benefit on the deal.

How anyone can possibly "predict" this sort of circumstance is beyond me. It can happen to just about anybody and I don't believe it was "in the genes" from the very beginning.