Leverage and Pricing of Debt in LBOs

37 Pages Posted: 17 Dec 2009 Last revised: 5 Dec 2011

See all articles by Paolo Colla

Paolo Colla

Bocconi University - Department of Finance; Bocconi University - BAFFI Center on International Markets, Money, and Regulation

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)

Hannes F. Wagner

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research; European Corporate Governance Institute (ECGI)

Date Written: September 6, 2011

Abstract

We show that the structure and pricing of debt in LBOs mostly depend on a single characteristic of the target firm, pre-LBO profitability. We find a positive relationship between pre-LBO profitability and deal leverage, that is consistent with a dynamic trade-off theory of capital structure in the presence of adjustment costs. We argue that the wide range of debt tranches used in LBO financing can be folded into two main categories, senior and junior debt, where the pricing of senior and junior debt depends on their relative use and on bankruptcy risk. Our evidence also suggests that senior lenders oversupply cheap credit during hot buyout markets.

Keywords: leveraged buyout, senior and junior debt, term loans, high-yield debt, private equity

JEL Classification: G30, G34

Suggested Citation

Colla, Paolo and Ippolito, Filippo and Ippolito, Filippo and Wagner, Hannes F., Leverage and Pricing of Debt in LBOs (September 6, 2011). Journal of Corporate Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1524155

Paolo Colla

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

Filippo Ippolito (Contact Author)

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(+34) 93 542 2578 (Phone)
(+34) 93 542 1746 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Hannes F. Wagner

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://mypage.unibocconi.eu/hanneswagner

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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