The financing and performance of leveraged buyouts
Abstract
The purpose of this investigation is to determine how leveraged buyouts are financed and to relate the characteristics of the target firm to the type of financing used. Interest deferral provisions, which are a financial innovation used in LBO financing, are also analyzed. Finally, this study follows changes in the capital structure after the LBO and relates the probability of financial distress after the buyout to the characteristics of the buyout transaction. Major findings, based on a sample of 107 large LBO firms, include: (1) During the 1980s, there was a trend towards substitution of issues of debt securities to replace bank financing. There was also a greater use of interest deferral provisions. (2) A multinomial logit model is found to be an appropriate choice model to relate characteristics of the target firm to the type of financing used. The evidence supports several hypotheses concerning the characteristics of firms that use funds from banks, debt securities, equity, and cash on hand. (3) On average, bonds with interest deferral provisions have yields 3/4% higher than equivalent bonds from the same firm without any deferral provision. (4) After the buyout, total debt is steadily paid down, but it levels off at an intermediate point without ever returning to its original level. (5) Capital expenditures fall dramatically after the buyout, but slowly climb back to their original level. (6) Firms that avoid financial distress tend to be large firms that underwent a buyout in the first half of the eighties, using equity as well as debt, and paying only a moderate premium over the previous market price of the firms' common stock. The results support Jensen's view that many of the benefits in LBOs can be attributed to increased levels of debt which control the agency costs of free cash flow. The results are also consistent with the notion that LBOs in the early eighties made economic sense, but as the market began to overheat, premiums became very large. With very heavy debt loads, many firms simply could not afford to pay for an overpriced deal.
Degree
Ph.D.
Advisors
Lewellen, Purdue University.
Subject Area
Management|Business costs
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