Monday, September 4, 2006

Ben Stein Punts One on Management Buyouts

I almost always enjoy reading whatever Ben Stein's writes - he's an old school kind of guy who generally hits most nails he aims at right on the head. But I got a kick out of his recent New York Times piece where he rails against the injustice of Management Buyouts (MBOs). Unfortunately, the reason I got a kick out of it is that his arguments are both over the top and incredibly off base.

He mentions MBOs in the same breath as segregation and housing discrimination, and says that " every standard I can see, they are yet another sad sign of how our corporate trustees have lost their moral compass."

Read the full piece here (Note: online subscription required)

The basic premise behind his screed (and I think it's an appropriate word) is that it's wrong for management to use their private information to buy up corporate assets on the cheap.

I have at least a couple of problems with his analysis:

First, what evidence I've seen on MBOs seems to show that the stockholders of the parent company make out about as well when a division is taken private in an MBO as they do when the division is sold to a third party (i.e. in an arms-length asset sale). So, managers on average seem to offer shareholders the same deal as they would have gotten elsewhere.

Second, I think Stein is guilty of "cherry picking." He may not be aware of it, but his cases are most likely not a representative sample. He gives some examples of MBOs where the management made a huge profit. However, the appropriate metric would be the returns for ALL MBOs, not just the successful ones.

Third, even if MBOs on average are extremely successful, the managers doing them bear a huge amount of risk. They typically take large equity stakes in these firms, and therefore end up holding an extremely undiversified position. If the MBO fails, they stand to lose what often represents a major portion of their personal wealth. And as we all know (at least, if we've taken an introductory finance class), bearing higher risk should be compensated by a higher expected return, or people won't take the risk.

Finally, in MBOs, managers typically pay a premium above the current perceived value of the division. And the shareholders APPROVE the deals (or at least the board of directors does). A evidence, the abnormal return to the firms selling the division are positive in most cases (and are statistically quite significant). If managers are making such a killing, it should show up in the returns to the parent company. It doesn't. And if it' such a good deal for the managers, why doesn't another firm swoop down and outbid them?

All in all, a disappointing piece, and not up to Stein's usual standards.

Oh well, everyone has an occasional off day. He does so many things so well that I guess he's due for one, too.

Update: For further commentary on the topic, be sure to read what Equity Private (Going Private) and Larry Ribstein (Ideoblog) have to say.

As usual, they say it better than me (damn!)

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