Corporate Capital Structure Decisions: Evidence from Leveraged Buyouts

Abstract

We analyze the composition of the financing packages used in a large sample of leveraged buyout transactions in order to test a set of hypotheses developed in the prior literature about the determinants of corporate capital structure decisions. We focus in particular on the role of agency costs, bankruptcy risks, and tax considerations. We find evidence that all three have an impact, both on the degree of leverage employed in the transactions and on the attributes of the borrowings undertaken. The impacts are manifest in systematic relationships between the proportion and type of debt in the buyout financing package and the target firm's earnings rate, earnings variability, growth prospects, and its tax and liquidity position. 0 The logic and consequences of leveraged buyouts (LBOs), both for the participants involved and for the economy as a whole, have been widely debated in the academic literature and the popular business press. In a leveraged buyout, a group of investors acquires the public interest in a firm's common equity, primarily with borrowed funds, and takes the firm private. We offer here some further evidence on the nature of these transactions, with particular emphasis on the composition of the LBO financing package. Our objective is to attempt to explain why the observed financing choices were made by individual firms-by identifying the relationships between the characteristics of the target firms and the types of financings that were employed in their acquisition. We detect some clear patterns in the data, many of which we believe have broader implications for the design of corporate capital structures. In particular, we find evidence that LBO financing decisions appear systematically to be affected by the target firm's growth prospects, the level and variability of its return on assets, its pre-buyout liquidity position, and by tax considerations and post-buyout restructuring plans. We find similar evidence of systematic influences on the