Industry Effects of LBO Events

Abstract

We explore the effects of leveraged buyouts (LBOs) on industry rivals of the firm undergoing the LBO. In particular, we seek to explain why certain firms experience strong positive market reactions and other firms experience strong negative market reactions. We find evidence that an industry effect exists that helps to explain why LBO targets cluster by industry such that there is persistence in LBO activity within an industry. This persistence does not appear to be connected to future shocks to the industry. This indicates that the rival wealth response may be related to future expected LBO offers within the industry, and not due to some expected future shock. We explore this hypothesis further by examining firm-level data. We find further evidence in favor of a pure acquisition hypothesis: that an LBO in an industry indicates that more LBOs will be attempted in the same industry. Our investigation then brings us to explore changes made by rival firms in response to the LBO activity. We document changes in capital expenditure and leverage among rivals. However, such changes appear to be transitive. Finally, we note that industry-level return variance increases following LBOs, but that rival firms’ industry betas decrease. We examine any effect this has on executive compensation packages but find little evidence of any large changes. In sum, our results indicate that the pure acquisition hypothesis is the most sensible hypothesis in explaining rival firms’ abnormal returns around LBO announcements.