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©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 15 - - - - - - - - ESOPs and MLPs.

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Presentation on theme: "©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 15 - - - - - - - - ESOPs and MLPs."— Presentation transcript:

1 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston Chapter ESOPs and MLPs

2 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2 Pension Plans Pension plans established to provide for payments to plan participants after retirement –Individual firm responsible for setting up pension fund –Firm makes dollar contributions to pension fund –Contributions are tax-deductible expenses at time of payment by company

3 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3 –Employees' wages are reduced to some degree to offset contributions by company to pension fund on behalf of its employees –Pension fund uses dollar contributions to make wide-range investments –Benefits of pension fund accrue to and are finally paid to pension beneficiaries who are company's employees –Benefits received are taxable to the recipients; dollar flows were not taxable at time of contribution

4 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4 Plans subject to federal government regulation by the Employee Retirement Income Security Act (ERISA) of 1974 Types of pension plans –Defined benefit plans Amounts participants receive in retirement specified by formula set in advance Two major types –Flat benefit formula — fixed amount per year of service –Unit benefit formula — fixed percentage of earnings per year of service

5 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5 Plan must meet federal fiduciary standards to qualify for favorable tax treatment Plan subject to minimum funding standards Plan guaranteed by Pension Benefit Guarantee Corporation (PBGC) –Defined contribution plans No fixed commitment to pension level Contributions are specified and participants receive over period of retirement what is in their account when they retire

6 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6 Three major types –Stock bonus plan — firm contributes annually specified number of shares of its common stock –Profit-sharing plan — contribution in cash based on profitability rates –Money purchase plan — contribution based on specific schedule Required by law to make "prudent" investments Plans not subject to minimum funding standards Plans not covered by PBGC

7 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7 Employee Stock Ownership Plans (ESOPs) Definition: –Defined contribution employee benefit pension plans designed to invest at least 50% of its assets in qualifying employer securities –ESOPs may be Stock bonus plans Combined stock bonus plans and money purchase plans May also provide for employee contributions May represent portion of profit-sharing plan

8 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8 –ESOPs different from: Employee stock purchase plans –Enable employees to buy company stock at discount –Participation of all or most employees –Shares sold at 85% or more of prevailing market price of shares Executive incentive programs –Provided mainly to top management and other key employees –Part of executive compensation packages –Two types Incentive stock options Stock appreciation rights

9 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9 Types of ESOPs –Leveraged Recognized under ERISA in 1974 Leveraged ESOP operation –ESOP fund or trust borrows funds from financial institutions –Lender transfers cash to ESOP trust in return for written obligation –Sponsoring (employer) firm generally guarantees loan –ESOP trust uses borrowed funds to purchase securities from sponsoring firm –Sponsoring firm transfers stock to name of ESOP trust as portions of principal are repaid

10 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10 –Source of payment of both interest and principal to financial institution is cash contributed to ESOP trust by sponsoring firm –Both interest and principal amount transferred by company are deductible expenses for tax purposes subject to some limitations –Leveragable Recognized under ERISA Plan authorized but not required to borrow funds –Nonleveraged Recognized under ERISA Plan does not provide for borrowing of funds Essentially stock bonus plan

11 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11 –Tax credits ESOPs Provided by Tax Reduction Act of 1975; known as Tax Reduction Act ESOPs or TRASOPs In addition to regular investment credit in existence at that time, additional investment credit of 1% of qualified investment in plant and equipment could be earned by contribution of that amount to ESOP In 1976, additional 0.5% credit added for companies that matched contributions of employees of same amount to TRASOP In 1983, basis for credit was changed from plant and equipment investments to 0.5% of covered payroll — plans called payroll-based ESOPs or PAYSOPs

12 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12 Uses of ESOPs Corporate restructuring activities –Buy private companies (59% of leveraged ESOPs) –Divestitures (37% of leveraged ESOPs) –Rescue operations of failing companies –Raising new capital –Takeover defense to hostile tender offers

13 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13 ESOPs as alternatives to mergers — for privately held firms –Motives to merge All in one basket — no diversification Illiquid position — no market for shares Avoid hasty "fire sale" to pay estate taxes –Mechanics of ESOP transaction Firm establishes ESOP ESOP borrows money in the amount the firm owner requires to diversify his position in a portfolio of publicly traded corporate securities Firm owner sells portion (over 30%) of his stock to the ESOP; value of stock = amount borrowed

14 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14 Owner may invest proceeds in securities of other U.S. corporations and defer any federal tax on transaction (tax-free rollover) if: –Investment is made within 12 months –ESOP owns at least 30% of firm's stock following sale –Neither owner nor his family participates in ESOP Firm makes tax-deductible contributions to ESOP sufficient to repay principal and interest Shares held by ESOP distributed to employees over time as loan repaid Results for firm owner: –Tax-free liquidity without selling firm to outsiders –May be able to retain control depending on amount of cash needed/proportion of stock sold to ESOP

15 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15 –ESOP considerations (for and against) Employee loyalty enhanced Liquidity and diversification for firm owner Minimizes dilution of control Establishes market value for privately held stock which could be used to value estate Provides a market for privately held stock — avoids "fire sale" of shares if stock needs to be sold to pay estate taxes Tax-free rollover is actually only a tax deferral until securities are sold 50% of proceeds from sale of securities to ESOP may be excluded from estate's value

16 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16 ESOPs in lieu of subsidiary divestiture –Alternatives for divesting a subsidiary Sell to another corporation — must find a buyer at an acceptable price Liquidate subsidiary's assets — disruptive to employees, customers, suppliers ESOP alternative — subsidiary's employees willing purchasers of subsidiary through ESOP

17 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17 –Mechanics of ESOP alternative Set up shell corporation which establishes ESOP Use debt capacity of shell corporation and ESOP (guaranteed by parent) to arrange financing to purchase subsidiary from parent Shell corporation (now no longer a shell) operates former subsidiary; ESOP holds stock As income is generated, tax-deductible contributions are made to ESOP so it can service debt As debt is paid off, shares are allocated to employee accounts Former subsidiary ends up owned by its employees

18 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18 Tax Advantages Scholes and Wolfson (1992) –Tax advantages of ESOPs may be illusory –Full deductibility of payments to ESOP for amortization of debt claimed to have tax advantages –Alternative pension benefit plans yield substantially same tax benefits

19 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19 Interest exclusion –Beatty (1995) — some tax provisions apply only to leveraged ESOPs Bank, insurance company, investment company can exclude from taxable income 50% of interest income earned on loans to ESOPs that own more than 50% of employer's equity Competitive markets would result in lower interest rates on ESOP loans than on non-ESOP loans –Interest loan exclusion was repealed in 1996

20 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20 Dividend deduction –Employer can deduct dividends paid on ESOP shares if they are allocated to employee accounts or used to repay ESOP debt –If dividends used to repay ESOP debt Value of ESOP shares declines by amount of dividend Net worth of ESOP contribution reduced by balance of ESOP loan that was repaid by dividend proceeds Employer can deduct entire market value of shares at time they are placed in ESOP which is higher than current value of ex-dividend shares

21 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21 Defer capital gains tax –Owner of closely held firm can defer capital gains from sale of firm by selling shares to ESOP –Sale must be for at least 30% of outstanding shares Tax loss carryforwards –Tax Reform Act of 1986 placed a number of restrictions on use of loss carryforwards after a change in control –Exception in case of an ESOP purchase of at least 50% of equity

22 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22 Excess pension asset reversion –In 1986, excise tax placed on reversions of excess assets from defined benefit plan –Lower excise tax rate if excess pension assets placed in ESOP Smaller expected present value tax deduction (disadvantage) –Smaller expected present value tax deduction for leveraged ESOPs compared to other retirement plans

23 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23 –Smaller deduction due to method of allocating ESOP assets to employees' account through a suspense account Shares purchased by leveraged ESOP initially placed in suspense account Shares are allocated to employees on percentage basis based on schedule of repayment of principal and interest in each year of loan Retirement plans, other than ESOPs, provide for immediate allocation of assets to employees Value of ESOP tax deduction based on market value of shares when placed in ESOP ESOP tax deduction cannot be taken until debt is repaid and assets are allocated some years in future

24 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24 Net tax benefits –Beatty (1995) — average net tax benefit was 0.3% of equity value for ESOPs established in 1987 and later –General Accounting Office (1986) Federal revenue losses from ESOPs about $13 billion for period Average of $1.9 billion per year –Net tax benefits would cause positive event returns for ESOP announcements

25 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25 Performance of ESOPs ESOPs as a takeover defense –Polaroid vs. Shamrock Holdings Delaware "freeze-out" law prevents hostile acquirer from merging with target unless 85% of target's voting shares are tendered Polaroid created ESOP which purchased 14% of its common stock Shamrock unable to obtain necessary 85% in 1988 tender offer After Polaroid, ESOPs became widely used as antitakeover strategy

26 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26 –Beatty (1995) Sample of 145 ESOP announcements 57% of transactions took place in 1988 and 1989 after Polaroid decision Negative returns on announcement of ESOP when firm subject to takeover attempt No change in returns on announcement of ESOP when firm is not subject to takeover attempt and size of ESOP provides effective blocking percentage ownership

27 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27 ESOPs versus alternative methods of raising funds –Corporate financing ESOPs provide benefits midway between debt and equity financing Can bring additional debt capacity to highly leveraged firms Debt interest expense under leveraged ESOP had been lower than straight debt financing when interest exclusion was permitted Provide market for equity financing for closely held firms

28 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28 Useful device for transferring ownership Most leveraged ESOP funds used to buy back stock from existing shareholders and not for capital expansion –Control of stock Management continues to control ESOP Employees who wish to maintain status quo or who do not want an outside company to take over firm, more likely to support management when ESOPs are used as takeover defense

29 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29 –Economic dilution ESOPs potentially transfer shareholders' wealth to employees If ESOP contribution not offset by reduction in other payments to workers, employees gain at expense of shareholders Any borrowing by ESOP uses some debt capacity of firm

30 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30 –Equity position dilution Infrequent use of ESOP loans suggests that nontax costs of using ESOP are high Large equity stake that goes to contributing employees significantly reduces equity stake to managers and buyout promoter Potential advantage: Shares can be sold at higher prices over the years as ESOP contributes to higher earnings through tax advantages and improved motivations of employees

31 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31 Comparison with profit sharing (Mitchell, 1995) –Deferred profit sharing plans in 16% of all firms compared with only 3% for ESOPs –ESOP's coverage of workers relatively small despite tax subsidies –Noninsured private pensions held $1.2 trillion in equity in 1991 compared with equity holdings of $47 billion for ESOPs –Compared to other pension plans, ESOPs have lesser impact on helping workers achieve equity holdings

32 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32 –Profit sharing has economic advantages over ESOPs Flexibility in worker compensation — improves stability of employment ESOP does not add to pay flexibility because it involves a form of bonus to employment –Owners have incentive to overvalue stock assigned to employees in ESOP plans in order to increase tax subsidy –Profit sharing schemes are more worthy of favorable tax treatment since they provide macroeconomic benefits

33 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33 Effects on company productivity –ESOP and stock voting rights Most studies indicate ESOP's stock ownership percentages of 10% or less Voting rights associated with stock of ESOP accounts may be exercised by plan trustees (usually company management) without input by participants ESOPs can be used by management to obtain tax benefits without sharing control with employees

34 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34 –General Accounting Office study (1987) No significant gains in either profitability or productivity Significant improvement in growth rate of sales in one study No significant improvement in growth rate of employment

35 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35 –Park and Song (1995) On average, firms with ESOPs improve performance Sample firms partitioned into firms with large outside blockholders (block firms) and firms without (nonblock firms) –Improvement in performance only in block firms –For nonblock firms, negative relation between fraction of ownership held by ESOPs and changes in performance –No systematic relationship for block firms

36 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36 –Conte, Blasi, Kruse, and Jampani (1996) Returns of firms with ESOPs significantly higher than comparable non-ESOP companies Financial returns decline after companies adopt ESOPs Results consistent with ESOPs used as takeover defenses Adoption of ESOPs in large companies lowers financial returns but no significant effect in smaller firms

37 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37 –Systematic studies of ESOPs in U.S. do not document performance improvement –Anecdotal evidence of positive effects on individual companies, e.g., United Airlines –Many cases where management has been unwilling to grant employees full shareholder rights when ESOPs are formed

38 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38 –ESOPs in Japan Positive results in sample of manufacturing firms for period Number of publicly traded firms with ESOPs jumped from 61% to more than 90% since 1973 Three to four years after creation of ESOPs, companies averaged 4-5% increase in productivity 10% increase in employee bonuses relative to bonuses of competitors resulted in 1% increase in productivity in next year

39 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39 Economic issues –Bargaining model (Ben-Ner and Jun, 1996) ESOPs analyzed in a bargaining game with asymmetric information –Management has superior information about firm's future cash flows –Employees attempt to overcome information disadvantage by making simultaneous offers on wages and purchase price for firm Owners of relatively unprofitable firms will establish ESOPs in lieu of higher wages Owners of more profitable firms will prefer to pay higher wages than dilute control by establishing ESOPs

40 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40 –ESOP may be used by management to increase control or conduct financial transactions in their own interest Hall-Mark Electronics — executives arranged ESOP to sell shares back to company for $4 per share before sale of company for $100 per share Chicago Pneumatic Tool Company — CEO transfers shares from company to ESOP under his own voting control to thwart hostile takeover Scott & Fetzer — ESOP-financed leveraged buyout; ESOP was putting more than 92% of equity investment for only 41% of equity ownership of the company

41 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41 –Chen and Kensinger (1988) If management controls ESOP — no increase in motivation for workers or better relation between workers and management If workers receive substantial increases in control over firm through ESOP — workers may use power to redistribute wealth away from other shareholders Appropriate employee ownership level should be better determined by market forces and not through use of tax subsidies

42 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42 Tax subsidies may cause misallocation of resources –Inefficient firms may "limp along" –Inefficient diversification of employees' capital may foster overly cautious attitude, discouraging investments –May cause distortions and departures from what would occur under unrestricted operation of market forces Greatest potential gains from employee ownership are in smaller high-growth companies — but in such companies, growth and profitability provide ample incentives Mature, diversified firms with few growth opportunities likely to be best candidate for ESOPs —- but ESOP financing should be compared with other alternatives that do not involve the same kind or same degree of tax subsidies

43 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 43 ESOP Event Returns –Chang (1990) Sample of 165 employee stock ownership plans Two-day announcement abnormal return for overall sample was positive 11.5% If ESOP used as LBO or as a form of wage concession, announcement results in small positive returns If ESOP established as takeover defense –Event returns are negative –Managers hold smaller ownership interest in their firms

44 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44 –Sellers, et al. (1994) Sample of ESOPs in which tax benefits not expected to be major influence Positive two-day return of 1.5%. Finding consistent with other favorable effects of ESOPs such as improvements in employee productivity –Chang and Mayers (1992) Nontax influences on event returns from establishment of ESOPs

45 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 45 Initial ownership level of officers and directors –Between 10% and 20% of total shares — largest positive returns –Less than 10% or more than 20% of total shares — smaller positive returns –More than 40% of total shares — negative association between event returns and fraction of shares added to ESOP –Beatty (1994) Companies that adopt ESOPs likely to have adopted other types of takeover defenses Companies that adopt ESOPs likely to have characteristics consistent with tax and incentive effects

46 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 46 –Beatty (1995) Sample of 122 ESOP announcements during Average 1% two-day positive return reflects primarily tax effects Relation between positive share price reaction and size of ESOP benefits Equity values decline for firms subject to takeovers –Chaplinsky, Niehaus, and Van de Gucht (1998) Positive three-day abnormal return of 13.3% for ESOPs Compared to 14.9% for management buyouts

47 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 47 Evaluation of ESOPs Comparison of ESOPs with management buyouts (MBOs) — (Chaplinsky, Niehaus, and Van de Gucht, 1998) –In MBOs officers and directors substantially increase their percentage ownership –In ESOPs workers do not effectively increase their control rights

48 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 48 –Prior to buyout transaction Transaction size (measured by median): ESOPs = $209 million, MBOs = $172 million Stock price performance: ESOP have poorer record Leverage (long-term debt to total capitalization): ESOPs = 12%, MBOs = 27% Takeover threats: more likely experienced by ESOP firms Ownership by officers and directors: ESOP had lower ratios

49 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 49 –After buyout transaction Compensation to employees: ESOP = reduced by 56%, MBO = reduced by 2.6% — ESOPs are used to reduce direct employment cost Leverage ratio (median) –ESOPs = 80% (include effects of reversion of excess pension fund assets), MBOs = 75% –ESOP firms use higher proportion of bank debt — greater tax subsidy to institutional lenders Industry adjusted employment growth over 3 to 5 year period: no great difference between ESOP and MBO firms Employees fail to obtain substantial control rights through ESOP formation

50 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 50 Effects on firm performance depend on how ESOPs are employed –For example, in industries (steel and airlines) where economic circumstances forced employees to give up portion of wages for partial equity position in firm Management continued to exercise major control Employees have not received full shareholder rights Ownership incentives have been severely diminished Many ESOPs established as takeover defenses, but proliferation of other defense methods has reduced their role

51 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 51 Tax advantages –Major tax advantage for owners of closely held corporations, but no clear effects on employee incentives –Tax subsidies involved with ESOPs might have negative consequences –Any positive effect of tax subsidies might be achieved more effectively through alternative compensation plans

52 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 52 Master Limited Partnerships (MLPs) Business organizational forms in general –Proprietorships and partnerships Most numerous Mostly small businesses –Corporations Dominant in terms of total assets

53 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 53 Four advantages in raising large sums of money –Limited liability for shareholders –Unlimited life –Ownership divided into many shares — limits risk exposure –Shares freely tradable for liquidity, diversification, transferability of ownership –MLPs — relatively new form of business organization

54 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 54 Master Limited Partnerships –Type of limited partnerships whose interests are divided into units that are traded on organized exchanges –First developed in oil and gas industry –Some advantages Unit tradability similar to stock Limited liability (for limited partners) Continuity of life No double taxation of business earnings

55 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 55 Tax treatment of MLPs –IRS focused on four characteristics to distinguish between corporations and MLPs Unlimited life Limited liability Centralized management Transferability –MLPs may have only two of four corporate characteristics to avoid being taxed as corporation — usually centralized management and transferability –MLPs typically specify limited life of 100 years –MLPs have limited liability for limited partners but unlimited liability for general partner or manager

56 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 56 General partner of MLPs –General manager (partner) of MLPs has unlimited liability –Virtually autocratic power –Difficult to change general partner in absence of provable fraud –Alignment of interests between general partner and public unit holders Management incentive fees Ownership of significant number of limited partnership units

57 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 57 Types of MLPs –Roll-up MLPs Combine existing limited partnerships into one publicly traded partnership First type of MLPs organized; began in oil industry by Apache Petroleum Company in 1981 Provide liquidity for nontraded limited partnerships Nature of roll-up –Before roll-up, there are a number of limited partnerships in existence –General partners enter into agreement to combine a number of previously sponsored limited partnerships; in return for their old shares, units in new MLP are issued –After MLP has been formed, there is a general partner and units which are owned by limited partners; units may trade on stock exchange or over the counter

58 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 58 –Roll-out (spin-off) MLPs Formed by a corporation's contribution of operating assets in exchange for general and limited partnership interests in MLP Sold on a yield comparison basis First roll-out MLP created by Transco Corp in 1983 Nature of roll-out –Corporation holds a number of business segments –Corporation places assets of one or more of its business segments into MLP Avoid double taxation of corporate dividends Establish a new value on undervalued assets –MLP transfers MLP units to corporation which in turn distributes them to its shareholders –Stockholder hold stock in corporation and own units in MLP –Corporation could sell portion or all of units to outside public

59 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 59 –Start-up (new issue, or acquisition) MLPs Formed by a partnership that is initially privately held but offers its interests to the public in order to finance internal growth Nature of start-up –Existing entity transfers assets to MLP –Management company may be involved that provides services to MLP and probably will be its general partner –In return, management company receives certain percentage of cash flows of MLP –General partner does not have to hold units in order to receive income

60 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 60 Initial pricing of MLPs –Muscarella (1988) Sample of initial public offerings (IPOs) of MLP units in 1983 to 1987 No significant under or overpricing Findings contrast with substantial underpricing of IPOs for corporate securities ( % initial average returns) Price performance of MLP units implies less uncertainty in valuation of MLP units compared to new corporate stock issues

61 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 61 –Moore, Christensen, and Roenfeldt (1989) Two-day return of 4.61% (significant) Reasons for positive market reaction –Tax advantages –Reduced information asymmetry –Improved asset management –Information signaling

62 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 62 Tax Law Changes –Revenue Act of 1987 provided that MLPs would be taxed as corporations except for partnerships involving oil and gas, timber, and real estate –MLPs existing on 12/17/87 would be "grandfathered" until after 12/31/97 –After 12/31/97, MLPs could elect, as an alternative to corporate taxes, to pay 3.5% of gross income –After 12/31/97, MLPs like Boston Celtics created multiple corporations and limited partnerships with cross-ownership relationships, apparently to minimize the impacts of the tax law changes


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