Leveraged Buyouts Research Articles

Amicus Brief: In Re Lyondell Chemical Company

Amicus Brief submitted in the Bankruptcy of Lyondell Chemical Company, analyzing fraudulent transfer issues by applying the techniques developed in Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution - http://ssrn.com/abstract=1632084.

Family firms versus leveraged buyouts: a conceptual comparison of distinctive governance structures

PurposeThe purpose of this paper is to compare the governance structures of two distinctive governance forms: the family firm and the leveraged buyout (LBO). The paper also explores the relative performance of these two organizational forms over the course of the economic business cycle.Design/methodology/approachThe paper provides a theoretical treatment of the family firm and the LBO using the stewardship perspective and agency theory. The analysis anticipates the board structure for each organizational form and relates family firm and LBO governance to performance over the business cycle.FindingsFrom a conceptual treatment, the family‐owned concern exhibits board characteristics reflecting the longer‐term orientation of the firm, with boards empowered to include non‐economic, as well as economic, goals. LBOs are structured to maximize shareholder value over a shorter time horizon. LBOs may take advantage of expansionary environments whereas family firms may be better prepared for economic down‐cycles.Research limitations/implicationsThe paper takes a holistic approach to contrasting two organizational forms that fit their respective theoretical frames and compares some of their more salient governance characteristics and performance over the business cycle.Practical implicationsManagers and boards can structure governance to manage the business cycle. Stakeholders can selectively engage firms that portray vital governance characteristics for their benefit and may also pressure boards and top management to make necessary governance improvements.Originality/valueThe paper offers an introductory comparison between family firms and LBOs in terms of governance and managing the firm over the business cycle. This paper makes the case that some organizational forms are better suited to certain types of economic climates.

Do Banks Build Bridges in LBO Transactions?

This paper documents connected leverage buyout (LBO) transactions in which acquiring private equity (PE) firms and target firms share common relationship banks. Connected LBO deals have lower prices, higher valuations and better qualities. Firms share common relationship banks as PE firms are 7% more likely to become targets in LBO transactions led by the same group of PE firms. Common relationship banks which build bridge between PE firms and target firms are 35% higher in probability to be chosen as lead bank in these LBO transactions and increase the future business interactions with these PE firms as well. I argue that banks build bridges between targets and acquirers in LBO transactions with their private information obtained through past business relations not only to strengthen business tie with PE firms, but also to generate business opportunity to boost their short and long run profitability.

Did Structured Credit Fuel the LBO Boom?

ABSTRACTThe leveraged buyout (LBO) boom of 2004 to 2007 was fueled by growth in collateralized debt obligations (CDOs) and other forms of securitization. Banks active in structured credit underwriting lent more for LBOs, indicating that bank lending policies linked LBO and CDO markets. LBO loans originated by large CDO underwriters were associated with lower spreads, weaker covenants, and greater use of bank debt in deal financing. Loans financed through structured credit markets did not lead to worse LBOs, overpayment, or riskier deal structures. Securitization markets altered banks' access to capital, affected their lending policies, and fueled the recent LBO boom.

What drives leverage in leveraged buyouts? An analysis of European leveraged buyouts’ capital structure

AbstractThis paper examines leverage in European private equity‐led leveraged buyouts (LBOs). We use a unique, self‐constructed sample of 126 European private equity (PE)‐sponsored buyouts completed between June 2000 and June 2007. We find that determinants derived from classical capital structure theories do not explain leverage in LBOs, while they do drive leverage in a control group of comparable public firms. Rather, we document that leverage levels in LBOs are related to the prevailing conditions in the debt market. In addition, our results indicate that reputed private equity sponsors use more debt and that secondary buyouts have higher leverage levels.

Operating Performance, Valuation, Leverage, and Corporate Governance of Leveraged Buy-Out Transactions: A Continental European Perspective

This article aims to analyse the evolution over the recent years of LBO funds, in terms of valuation (asset prices) and the role that leverage and corporate governance played in its evolution.Leverage is one of the positive factors that is supposed to contribute to the success of private equity, among other things through its positive impact on corporate governance. However, private equity has also other tools and means that can contribute to value creation and thus the model’s success. Using a data panel composed of Continental European transactions between 1997 and 2010, the strong presumption that the abuse of the leverage effect has contributed to corrupt the fundamentals of the model and also contributed significantly to rising asset prices offered by LBO funds over the last years is verified. In addition to leverage, the booming M&A market, along with an increasing trend of private equity to pursue build-up strategies also contributed to such asset price inflation.The conclusion is that LBO, as an investment model, seems to behave along the classical patterns over the medium terms, the recent phenomenon being linked to cyclical effects that may have caused LBO funds to forget about the underlying rational understanding of previously successful model. This may not cause a structural problem as long as LBO funds are capable of switching back to the fundamentals driving their initial success.

Growth LBOs

Using a data set of 839 French deals, we look at the change in corporate behavior following a leveraged buyout (LBO) relative to an adequately chosen control group. In the 3 years following a leveraged buyout, targets become more profitable, grow much faster than their peer group, issue additional debt, and increase capital expenditures. We then provide evidence consistent with the idea that in our sample, private equity funds create value by relaxing credit constraints, allowing LBO targets to take advantage of hitherto unexploited growth opportunities. First, post-buyout growth is concentrated among private-to-private transactions, i.e., deals where the seller is an individual, as opposed to divisional buyouts or public-to-private LBOs where the seller is a private or a public firm. Second, the observed post-buyout growth in size and post-buyout increase in debt and capital expenditures are stronger when the targets operate in an industry that is relatively more dependent on external finance. These results contrast with existing evidence that LBO targets invest less or downsize.

Masonite International Corporation: Case Study Of A Leveraged Buyout

This case study deals with the leveraged buyout of door manufacturer and merchandiser Masonite International Corporation, at a time of uncertainty, marked by the ever-increasing cost of raw materials, the tightening of monetary policy, and the concerning health of the housing market. It offers the opportunity to discuss leveraged buyouts, to value the company, and to analyze the financing of the transaction.

Buyout Activity and Asset Prices

We develop a model in which leveraged buyout (LBO) transactions are sensitive to variation in pricing conditions. The privatization of the firm generates value by eliminating agency costs that impede the firm’s growth; however, LBO investors require compensation to commit their capital to a single, undiversified project. These quantities are derived in an economy with long-run risk and recursive preferences. We conclude that more buyouts should occur when risk-free rates are high and the risk premium is low. In a panel dataset of public companies from 1980 to 2009, we document that LBO activity is positively related to the risk-free rate and negatively related to expected excess returns. We find the aggregate discount rate, rather than credit specific factors, is an important determinant of LBO activity. We also predict firms with higher exposure to systematic shocks and higher idiosyncratic risk are less likely to LBO. In the data, we find firms are less likely to privatize if they have a high market beta, residual variance, or cash flow volatility.

The Private Equity Advantage: Leveraged Buyout Firms and Relationship Banking

This article examines the impact of leveraged buyout firms' bank relationships on the terms of their syndicated loans. We examine a sample of 1,590 loans financing private equity sponsored leveraged buyouts between 1993 and 2005, and find that private equity firms' bank relationships are an important factor in cross-sectional variation in the loan interest rate and covenant structure. Our results indicate that bank relationships formed through repeated interactions reduce inefficiencies from information asymmetry and allow leveraged buyouts sponsored by private equity firms to occur on favorable loan terms. A one-standard-deviation increase in bank relationship strength is associated with an 8-basis-point (3%) decrease in the spread and a 0.21-basis-point (4%) increase in the maximum debt to EBITDA covenant. We also find evidence that banks price loans to cross-sell other fee business. A one-standard-deviation increase in both bank relationship strength and cross-selling potential translates into as much as a 4-percentage-point increase in equity return to the leveraged buyout firm. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

차입 인수합병기업의 소유구조 선택

인수합병(LBO)을 실행한 기업중 외부차입이 큰 경우에는, 일정기간 후에 인수비용을 충당하기 위해 차입한 막대한 자금을 상환하기 위해 일반 기업공모나 제3자 기업매각을 시도할 수 있다. 일반 기업공모는 소유지분 공개를 통한 공기업으로의 전환이고, 제3자 기업매각은 소유구조상 사기업 형태의 지속을 의미한다. 따라서 외부차입에 의한 인수합병 기업의 소유구조 선택은 최초공모주(IPO) 발행을 통한 공기업으로의 전환인가 또는 제3자 기업매각을 통한 사기업 형태의 유지인가에 대한 의사결정의 문제이다. 국내에서는 외부차입에 의한 인수합병(LBO) 사례가 매우 적다. 그러나 해외에서는 외부차입에 의한 인수합병(LBO) 거래가 폭발적으로 증가하여 오고 있고, 이러한 거래가 금융시장에 미치는 영향 또한 지대하다. 본 연구는 미국의 기업자료를 대상으로 기업의 경영자가 외부차입을 통한 인수합병을 실행한 기업의 소유구조 선택에 어떠한 요인들이 영향을 미치는가를 분석하였다. 연구결과, 인수합병의 규모, 호황 불황 등 시장 상황 등이 차입을 통해 인수합병을 실행한 LBO 기업이 계속 사기업 형태로 유지할지 또는 기업공개를 시도하여 공기업으로 전환할지 하는 소유구조의 선택 의사결정에 중대한 영향을 미치는 것으로 나타났다. Leveraged buyouts (LBO) means the acquisition of a company using bonds and loans. There are the prolific volumes of LBO transactions in the international M&A markets, and its influence to the financial market is increasingly huge. However, there are very few LBO transaction in the domestic M&A market and there are also few researches in this field due to the private nature of LBO transactions. Once a company is privatized through a LBO transaction, it is not so long before it is relisted on the stock exchange or it is resold to a third-party investor. In order to repay the borrowed money, an LBO investor may decide to end a company's private status through an exit via an initial public offering (IPO) or a takeover. In this paper, we expand Kaplan's study on the organizational status of post leveraged buyout (LBO) transaction. We find that there is a significant change starting 1986. Most notably, fewer LBOs remain private, the median holding period of the LBO was cut in half to 3.2 years and of those that exit, IPO exits had significantly shorter holding periods. Regression analysis shows that good market conditions lengthen the holding period of a LBO investment whereas the size of the transaction shortens it.

IPO Timing, Buyout Sponsors’ Exit Strategies, and Firm Performance of RLBOs

AbstractThis paper studies the impact of buyout sponsors’ initial public offering (IPO) timing on the leveraged buyout (LBO) restructuring process and subsequent exit strategies. I find that LBO duration is negatively related to hot IPO market conditions. Further, following IPOs, reverse leveraged buyouts (RLBOs) with shorter LBO duration experience greater deterioration of performance and higher probability of bankruptcy. This suggests that sponsors’ efforts to enhance operating efficiency succumb to market timing. IPO timing does not affect sponsors’ exit strategies and monitoring post IPO. Sponsors keep an active long-run presence with more reputable sponsors who are more likely to exit by facilitating takeovers.

Private Equity and Long‐Run Investment: The Case of Innovation

ABSTRACTA long‐standing controversy is whether leveraged buyouts (LBOs) relieve managers from short‐term pressures from public shareholders, or whether LBO funds themselves sacrifice long‐term growth to boost short‐term performance. We examine one form of long‐run activity, namely, investments in innovation as measured by patenting activity. Based on 472 LBO transactions, we find no evidence that LBOs sacrifice long‐term investments. LBO firm patents are more cited (a proxy for economic importance), show no shifts in the fundamental nature of the research, and become more concentrated in important areas of companies' innovative portfolios.

Who Benefits from the Leverage in LBOs?

Tax savings associated with increased levels of debt are often thought to be an important source of returns for private equity funds conducting leveraged buyouts (LBOs). However, as leverage is available to all bidders, the vendors may appropriate any benefits in the form of the takeover premium. For the 100 largest U.S. public-to-private LBOs since 2003, we estimate the size of the additional tax benefits available to private equity purchasers. We find a strong cross-sectional relationship between tax savings and the size of takeover premia; and on average the latter are around twice the size of the former. Consequently, the tax savings from increasing financial leverage essentially accrue to the previous shareholders rather than the private equity fund that conducts the LBO. It is, therefore, unlikely that (ex ante predictable) tax savings are an important source of returns for private equity funds. Furthermore, policy proposals that aim to restrict leverage or the tax-deductibility of debt are likely to have their impact mainly on existing owners of companies.

Structure and Determinants of Financial Covenants in Leveraged Buyouts*

The authors use proprietary loan contracts and financial information negotiated between banks and private equity sponsors to explore the financial covenant structure and the determinants of covenant restrictiveness in a large set of leveraged buyouts. With respect to the covenant structure, we analyze the utilized types of financial covenants in sponsored loans and in comparable nonsponsored loans, such as highly levered term loans or loans used toward M&A. The authors find that sponsored loans show less variation in the included types and combinations of covenants and include more financial covenants than the comparable nonsponsored loans. With respect to covenant restrictiveness, the authors measure precisely the distance between threshold and financial forecast. They show that two competing mechanisms, reduced information asymmetry costs and increased financial risk, affect the restrictiveness in sponsored loans.

Shall We Dance? Syndication, Social Network, and Performance: Evidence from Leveraged Buyout Investments

This paper examines how the educational profiles of the LBO management team, in particular the MBA graduates (MBAs) from prominent schools who tend to have strong alumni networks, might influence syndication decisions. With a unique hand-collected dataset of 941 LBO investments, I find that MBAs are not prone to syndication, and they tend to work with their cohorts when they syndicate, especially when agency costs exist. There exists a non-linear relationship between syndication and performance, indicating the inherently different natures of deals. MBAs perform better in non-syndicated deals but not in syndicated ones. It thus suggests that MBAs are good at pre-deal screening and might explain why they would seek outside expertise when needed. Overall, my findings show that syndication allows for the making of deals that otherwise may not be possible, and MBA alumni networks seem able to facilitate information flows and also to alleviate agency costs associated with co-investors.

Agency Problems in Public Firms: Evidence from Corporate Jets in Leveraged Buyouts

This paper uses rich, new data to examine the fleets of corporate jets operated by both publicly traded and privately held firms. In the cross-section, firms owned by private equity funds average jet fleets at least 40 percent smaller than observably similar publicly-traded firms. Similar fleet reductions are observed within firms that go private in leveraged buyouts. I discuss assumptions under which comparisons across and within firms provide estimates of lower and upper bounds on the average treatment effect of taking a firm from public to private in a leveraged buyout. Both censored and standard quantile regressions suggest that results at the mean are driven by firms in the upper 30 percent of the conditional jet distribution. Results thus suggest that executives in a substantial minority of public firms enjoy more generous perquisites than they would if subject to the pressures of private equity ownership.

Creative destruction? Evidence that buyouts shed jobs to raise returns

Building on the work of Cressy, Munari, and Malipiero (2007a) which showed that buyouts have higher operating profitability in the post-buyout period than matched companies, the paper examines contradictory popular claims that private equity (PE)-backed leveraged buyouts (LBOs) generate or destroy jobs as a result of the process of ‘rationalisation’. Using a sample of up to 57 UK whole-company buyouts and a matched sample of up to 83 controls over the period 1995–2000 we run loglinear employment regressions for one to five years after the buyout with buyout year variables as regressors. A PE dummy represents companies that have PE backing while other variables control for initial employment, gearing, investee size and profitability together with industry and macro effects. We find that there is no PE-‘choice’ effect: in the buyout year there are no significant differences between buyout companies and controls in terms of employment. But in the post-buyout regressions the PE dummy is highly significant and negative reaching a peak of 23% per annum after four years. So to achieve efficiency gains, buyouts bring about quick and substantial reductions in employment in target companies during the initial period of ‘rationalisation’. However, initial profitability, three-year average post-buyout profitability and three-year sales growth have positive elasticities with respect to future employment suggesting that buyouts, by generating higher operating profits from job cuts, may ultimately be associated with compensating job creation. This, however, is the subject for future research.

Shall We Dance? Syndication, Social Network, and Performance: Evidence from Leveraged Buyout Investments

Shall We Dance? Syndication, Social Network, and Performance: Evidence from Leveraged Buyout Investments

CEO Turnover in Private Equity Sponsored Leveraged Buyouts

Manuscript Type: Empirical Research Question/Issue: We examine the governance role of private equity (PE) firms in post-LBO companies in the US. We propose and test whether PE firms remove entrenched CEOs or CEOs who cause agency problems. Research Findings/Insights: Using archival data from a sample of 126 PE sponsored LBOs in the USA between 1990 and 2006, we document a CEO turnover rate of 51 per cent within two years of an LBO announcement. We find that the boards of directors replace CEOs in companies with high agency costs, as measured by low leverage and a high level of undistributed free cash flow. In addition, unlike the boards of directors in public companies, the boards in post-LBO companies tend to replace entrenched CEOs. Finally, the boards are more likely to replace CEOs if pre-LBO return on assets is low. Theoretical/Academic Implications: According to the agency theory, a PE-sponsored LBO is a new organizational form that reduces agency costs by enhancing corporate governance. This study uses CEO turnover as a setting to test that prediction. We find that PE firms replace CEOs who can cause agency problems, thus providing empirical support for the proposition that PE firms improve corporate governance in LBO companies. Practitioner/Policy Implications: This study offers insights to policy makers who are interested in regulating PE firms. Our results suggest that, in the US, PE firms provide effective corporate governance mechanisms by replacing incompetent and entrenched CEOs. In addition, our results provide a set of factors for PE firms to consider when they make CEO retention decisions.