Abstract

http://ssrn.com/abstract=2251169
 
 

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A Theory of LBO Activity Based on Repeated Debt-Equity Conflicts


Andrey Malenko


MIT Sloan School of Management

Nadya Malenko


Boston College - Carroll School of Management

January 30, 2014


Abstract:     
We develop a theory of LBO activity based on two elements - the ability of PE-owned firms to borrow against their sponsors' reputation with creditors, and externalities in sponsors' reputations due to competition and club formation. In equilibrium, the two sources of value creation in LBOs - operational improvements and financing - are complements. Moreover, sponsors that never add operational value cannot add value through financing either. Club deals are beneficial ex-post by allowing low-reputation bidders with high valuations to borrow reputation from high-reputation bidders with low valuations, but can destroy value by reducing bidders' investment in reputation. Unlike leverage of independent firms, driven only by firm-specific factors, buyout leverage is driven by economy-wide and sponsor-specific factors. Buyout activity decreases, while the composition of acquirers and PE firms' payoffs are non-monotonic in discount rates. Finally, adding value through financing is easier when operational improvements come from common values (e.g., poor performance of current management) rather than private values (e.g., sponsor's expertise).

Number of Pages in PDF File: 63

Keywords: Private equity, leveraged buyout, LBO, reputation, club deals, externalities, capital structure, debt-equity conflicts

JEL Classification: G23, G32, G34

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Date posted: April 16, 2013 ; Last revised: January 31, 2014

Suggested Citation

Malenko, Andrey and Malenko, Nadya, A Theory of LBO Activity Based on Repeated Debt-Equity Conflicts (January 30, 2014). Available at SSRN: http://ssrn.com/abstract=2251169 or http://dx.doi.org/10.2139/ssrn.2251169

Contact Information

Andrey Malenko
MIT Sloan School of Management ( email )
100 Main Street
E62-619
Cambridge, MA 02142
United States
617-225-9301 (Phone)
HOME PAGE: http://www.mit.edu/~amalenko
Nadya Malenko (Contact Author)
Boston College - Carroll School of Management ( email )
140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
HOME PAGE: http://www2.bc.edu/nadya-malenko/
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