Manage the Risks of Privatization

Women Leading Research: Hanna Lee

SMITH BRAIN TRUST – While privatization comes with benefits — like not being beholden to market speculation or a chorus of diverse shareholders — it also carries risks. Privately held companies, for instance, have limited access to public equity markets, which complicates their ability to keep operations afloat when cash is tight.

Research by Hanna Lee, assistant professor of accounting and information assurance at the University of Maryland’s Robert H. Smith School of Business, further demonstrates why privately owned companies are risky investments.

Lee and three co-authors analyzed a sample of public bonds to determine how the cost of public debt differs between privately and publicly owned companies. Their research revealed that, after controlling for factors identified by past research as affecting the cost of debt (including firm fundamentals, bond characteristics and the firm’s information environment), the cost of public debt issued by privately owned companies — as captured by ratings and yield spreads — is significantly higher than that issued by publicly owned companies.

The researchers also found that distress events happened more regularly for private firms, at least relative to what would be expected based on their fundamentals. This creates a greater default risk for their creditors, which is likely related to the aforementioned dilemma of public equity markets being largely out of reach for private firms. What’s more, private firms experience a higher cost of debt during recessions, periods in which accessibility to the capital market is critical to avoid default.

But not all privatization is created equal. The research sheds light on how ownership type also influences bond spreads and credit ratings. Specifically, ownership by private equity firms is associated with a higher cost of debt. That’s consistent with previous research indicating that more separation of ownership and control in private equity-backed companies may lead to more risk taking.

Size matters, too. Ownership by large private equity firms is associated with a lower cost of debt to their investees as compared to ownership by smaller private equity firms. This makes sense considering large private equity firms have greater reputational concerns as repeated players in the capital markets.

So in the battle between public and private ownership, which takes the crown? The research suggests that going the public route may be better for the risk-averse. Although here’s one last revelation to consider: Private, employee- or family-owned companies are often considered less risky than their private equity-owned counterparts. That, too, can likely be attributed to the effects of a disconnect between ownership and management in companies owned by private equity firms.

Read more:  Private Ownership and the Cost of Debt: Evidence from the Bond Market is featured in Management Science.

Hanna Lee is an assistant professor of accounting and information assurance at the University of Maryland’s Robert H. Smith School of Business.

Research interests: Predictive information in financial statements, usefulness of accounting information in debt markets, default prediction, disclosure, and financial reporting quality. 

Selected accomplishments: Presented her study investigating the increase in forecasting accuracy of hazard rate bankruptcy predication models with creditor coordination effects at the 2011 American Accounting Association Annual Meetings. Completed her doctoral work at Columbia University and earned a master’s degree in statistics from Harvard University, a BS at Seoul National University, and studied economics for a summer at the London School of Economics. Worked professionally for Goldman Sachs in New York, Deutsche Bank and Citibank in Seoul, South Korea, and AsiaNet Corp.

About this series: The Smith School faculty is celebrating Women’s History Month 2018 in partnership with ADVANCE, an initiative to transform the University of Maryland by investing in a culture of inclusive excellence. Daily faculty spotlights support activities from the school’s Office of Diversity Initiatives, starting with the seventh annual Women Leading Women forum on March 1, 2018.

Other fearless ideas from:  Rajshree Agarwal  |  Ritu Agarwal  |  T. Leigh Anenson  |  Kathryn M. Bartol  |  Christine Beckman  |  Margrét Bjarnadóttir  |  M. Cecilia Bustamante  |  Jessica M. Clark  |  Rellie Derfler-Rozin  |  Waverly Ding  |  Wedad J. Elmaghraby  |  Rosellina Ferraro  |  Rebecca Hann  | Amna Kirmani  |  Hanna Lee  |  Hui Liao  |  Jennifer Carson Marr  |  Wendy W. Moe  |  Courtney Paulson  |  Louiqa Raschid  |  Rebecca Ratner  |  Debra L. Shapiro  |  M. Susan Taylor  |  Niratcha (Grace) Tungtisanont  |  Vijaya Venkataramani  |  Janet Wagner  |  Yajin Wang  |  Yajun Wang  |  Liu Yang  |  Jie Zhang  |  Lingling Zhang