Broken Promises: The Role of Reputation in Private Equity Contracting and Strategic Default
Matthew D. Cain
U.S. Securities and Exchange Commission
Steven Davidoff Solomon
University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy
Antonio J. Macias
AFA 2012 Chicago Meetings
This paper examines reputation and contract design in private equity acquisitions. We use a novel dataset of both completed and terminated private equity buyouts from 2004 through 2010. We find that private equity firms and targets rely on reputation to fill intentional contractual gaps. During the financial crisis private equity firms complete uneconomic, pre-agreed takeovers up to the point when estimated buyout losses rise to at least 7% of sponsors’ fund sizes, or $200 to $400 million in nominal values. Target firms are willing to engage with defaulting private equity firms in future transactions but they penalize these firms by demanding significantly larger contract nonperformance penalties. We conclude that both reputation and explicit contracting can play important and interrelated roles in private equity and complex business relationships generally.
Number of Pages in PDF File: 51
Keywords: private equity, reputation, contracting, termination
JEL Classification: G34, G30, K12, L14
Date posted: January 23, 2010 ; Last revised: September 11, 2012
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