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Inside Wall Street Two Arrows

Management Buy-Outs (LBOs)
by WealthEffect Staff

 
 
This form of takeover is particularly controversial, and probably unfair. In this situation, a company's management — the people who are responsible for maximizing the stock price — instead purchase the outstanding shares of their company for themselves. They pay a premium for the stock and usually finance most of the purchase price with debt, a transaction known as a leveraged buy-out (LBO). What distinguishes this from any other takeover is the fact that the managers know more about their company and its prospects that anyone, even their employers. (They'd better know more — that is their job.)

Obviously, a management that proposes a buy-out believes that the stock is undervalued relative to its potential value. Otherwise, why else would they want to buy it? The point is, however, that it is their responsibility to realize the value of these assets for the stockholders, not for themselves. If the company is being undermanaged due to insufficient expertise or poor strategic fit or excessive overhead, it's somewhat ludicrous to allow the ones who caused the problem to profit from it. And yet they have.

If stock prices had fallen and interest rates had risen during the 1980s and 1990s, and if management LBOs had collapsed instead of prospered, would this argument have been different? No, just less relevant. In the stock market, no one is given the right to profit from material information that is not available to the public, least of all the people who are paid — and paid well — to make money for their investors.

 
 


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