What makes private equity firms target a publicly traded company for takeover?

A new study from the Tippie College of Business finds that private equity is often likely to target firms that more aggressively manage their earnings to meet analysts’ quarterly expectations.

Paul Hribar, professor of accounting in the Tippie College of Business, said this phenomenon is called earnings myopia because managers are overly focused on near-term earnings at the expense of long term growth and value creation. 

Paradoxically, myopia often stems from managers’ fear they will become a more tempting target for a takeover when they miss their earnings expectation. Managing earnings is used as a short-term tool to keep the stock price up and thwart a takeover attempt. 

But Hribar said his study suggests that if they manage earnings to the point of myopia, they’re actually making themselves an even bigger target.

The study looked at 3,200 private equity acquisitions between 1999 and 2018 and found those public companies that exhibit high levels of earnings myopia are more likely to be acquired. 

The study found that private equity is willing to pay more for these firms, too, with acquisition prices of myopic firms fetching a 7% premium. The study attributes that premium to the value that can be unlocked by alleviating the company’s short-term focus.

Hribar said this often leads to a better future for the firm because the private equity owners are likely to invest heavily in research and development to kickstart growth and build value in their new acquisition. As a result, they tend to see improvements in productivity and profitability following the takeover. 

Hribar pointed to the 2022 takeover of Zendesk by private equity as an example. Innovation at the cloud-based customer service provider seemed to have stagnated under the heavy pressure to meet shareholder expectations, and it was ultimately sold to a consortium of private equity investors. 

Less than a year after the acquisition, Zendesk bought app developer Tymeshift, suggesting the private equity owners were investing in the new addition to their portfolio. 

Media contact: Tom Snee, 319-384-0010 (o); 319-541-8434 (c); tom-snee@uiowa.edu