Borrow cheap, buy high? The determinants of leverage and pricing in buyouts

Private equity funds pay particular attention to capital structure when executing leveraged buyouts, creating an interesting setting for examining capital structure theories. Using a large, detailed, international sample of buyouts from 1980-2008, we find that buyout leverage is unrelated to the cross-sectional factors – suggested by traditional capital structure theories – that drive public firm leverage. Instead, variation in economy-wide credit conditions is the main determinant of leverage in buyouts, while having little impact on public firms. Higher deal leverage is associated with higher transaction prices and lower buyout fund returns, suggesting that acquirers overpay when access to credit is easier

Insight private equity : [Version 18 June 2013]

We are able to shed light on the black box of restructuring tools private equity investors use to improve the operational performance of their portfolio companies. By building on previous work considering performance evaluation of PE backed companies, we analyze whether private equity improves operating efficiency and which of the typical restructuring tools are the main performance drivers. Using a set of over 300 international leveraged buyout transactions of the last thirty years, we find that while there is vast improvement in operational efficiency, these gains vary considerably. Our top performing transactions are subject to strong equity incentives, frequent asset restructuring and tight control by the investor. Furthermore, investors’ experience has a positive influence while financial leverage has no influence on operational performance

The Real Effects of Private Equity Buyouts

Private equity buyouts have become a common element in the industrial development process. I survey the literature on the real economic effect of buyouts: employment, wages, productivity, and long-run investments. Employment tend to marginally fall after a buyout in most countries studied, with the exception being France. There are clear evidence of productivity gains following a buyout, with part of these being shared with worker through higher wages. The evidence is mixed regarding effects on long-run investments.Employment; Innovation; Leveraged Buyouts; Long-run investments; Private equity buyouts; Productivity; Real effects

Livelihood Disruption and Venture Creation: Entrepreneurship as Technology Adoption A Comparison between Kentucky and Shaanxi Farmers

In the US, The Tobacco Transition Payment Program, also called the "tobacco buy-out," helps tobacco quota holders and producers transition to the free market. In China, the transaction of Land Use Rights providing farmers’ ability to buy or sell Land Use Rights has been seriously considered by the Chinese government. The uncertainty in household income and changes in economic environment during the US Tobacco Transition Payment Program and the Chinese Land Use Rights Regime lead many individuals into entrepreneurial activities. Entrepreneurship often means making changes in livelihood activities that involve substantial risks to income. While the rewards may be substantial, transactions costs may make decisions irreversible. This paper draws a comparison between entrepreneurship and technology adoption. Adopting a new production technology also involves substantial risks. The economics of technology adoption is a well developed literature with many accepted and testable models. Most prominent are the theories of learning by using and learning by doing. We review the technology adoption literature, drawing out lessons for entrepreneurship research. We then apply an ‘entrepreneurship as technology adoption’ model to a unique dataset collected in Kentucky, US and in Shaanxi province, China. Using a sample of 702 Kentucky farmers at the time of the buyout and 730 Chinese farmers, we test several of the implications of this model and compare significant results between Kentucky and Shaanxi farmers. This study finds that both farmers in Kentucky and Shaanxi with a strong social network are more likely to become entrepreneurs. Kentucky farmers with low income are more likely to start new businesses. The finding supports the “push” hypothesis as farmers with low income are pushed into starting a new business. The human capital factor is strongly associated with Shaanxi farmer’s entrepreneurial decision.Farm Management, Research and Development/Tech Change/Emerging Technologies,

Navigating the new world of private equity - a conference summary

The Federal Reserve System's Private Equity Merchant Banking Knowledge Center, formed at the Chicago Fed in 2000 shortly after the passage of the Gramm–Leach–Bliley Act, sponsors an annual conference on new industry developments. This article summarizes the 2008 conference held on July 9 - 10.Private equity ; Investments

The performance of private equity funds

Using a unique and comprehensive dataset, the authors show that the sample of mature private equity funds used in previous research and as an industry benchmark is biased towards better performing funds. They also show that accounting values reported by these mature funds for non exited investments are substantial and they provide evidence that they mostly represent living dead investments. After correcting for sample bias and overstated accounting values, average fund performance changes from slight over performance to substantial underperformance of -3.83% per year with respect to the S&P 500. Assuming a typical fee structure, they find that gross-of-fees these funds outperform by 2.96% per year. The authors conclude that the stunning growth in the amount allocated to this asset class cannot be attributed to genuinely high past performance. They discuss several potentially misleading aspects of standard performance reporting and discuss some of the added benefits of investing in private equity funds as a first step towards an explanation for our results.Private equity funds; performance

Do private equity owners increase risk of financial distress and bankruptcy?

There is some controversy on the key sources of success in the private equity model and on how this business model affects the portfolio companies. We investigate financial distress risks of European companies around the buyout event in the period between 2000 and 2008. In addition, we analyze whether buyout companies go bankrupt more often than comparable non-buyout companies. Our paper suggests that private equity investors select companies which are less financially distressed than comparable companies and that the distress risk increases after the buyout. Despite this increase, private equity-backed companies do not suffer from higher bankruptcy rates than non-buyout companies. In fact, when companies are backed by experienced private equity funds, their bankruptcy rates are even lower. Experienced investors seem to be better able to manage distress risks than their inexperienced counterparts. --private equity,buyout,financial distress,bankruptcy

What does it take to be good parent ? Opening the black-box of value creation in the unrealated multibusiness firm

This paper develops and tests new theory about the determinants of value creation in unrelated multibusiness firms from a resource-based perspective. The authors argue that the availability of "headquarter resources", which are at the basis of headquarter services provided to the business units, is the driving force behind unrelated diversification.diversification; private equity; management buyout; leveraged buyout; resource-based view; parenting effect; conglomerate

Giants at the Gate: On the Cross-section of Private Equity Investment Returns

We examine the determinants of private equity returns using a newly constructed database of 7,500 investments worldwide over forty years. The median investment IRR (PME) is 21% (1.3), gross of fees. One in ten investments goes bankrupt, whereas one in four has an IRR above 50%. Only one in eight investments is held for less than 2 years, but such investments have the highest returns. The scale of private equity firms is a significant driver of returns: investments held at times of a high number of simultaneous investments underperform substantially. The median IRR is 36% in the lowest scale decile and 16% in the highest. Results survive robustness tests. Diseconomies of scale are linked to firm structure: independent firms, less hierarchical firms, and those with managers of similar professional backgrounds exhibit smaller diseconomies of scale.Private Equity, investment, LBOs, Buyouts

Leveraged Buyouts and Private Equity

We describe and present time series evidence on the leveraged buyout/private equity industry, both firms and transactions. We discuss the existing empirical evidence on the economics of the firms and transactions. We consider similarities and differences between the recent private equity wave and the wave of the 1980s. Finally, we speculate on what the evidence implies for the future of private equity.PrivateEquity