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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 2015

Journal of Financial Economics (JFE), Forthcoming

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.

Number of Pages in PDF File: 64

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 8, 2015

Suggested Citation

Malenko, Andrey and Malenko, Nadya, A Theory of LBO Activity Based on Repeated Debt-Equity Conflicts (January 2015). Journal of Financial Economics (JFE), Forthcoming. 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
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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