Pre-LBO Credit Market Conditions and Post-LBO Target Behavior

Abstract

In the context of leveraged buyouts (LBOs), this paper empirically studies the relation between pre-buyout credit market conditions and the post-buyout behavior of target companies, employing a supervisory dataset to overcome limited data availability for post-buyout target financial information. We propose an LBO-specific measure of (changes of) credit market conditions---the short-term (6-month) change of credit spreads leading up to buyout close. Using this proposed measure, we show that loosening pre-LBO credit market conditions, which are related to higher buyout leverage consistent with the literature, are associated with poor post-LBO (operating) performance of the target company. These results support the narrative of agency costs of debt such as risk shifting and debt overhang but are inconsistent with theories of disciplinary effects of debt. We provide further evidence supportive of the theories of agency costs of debt and some results favorable to the risk shifting story.