Why are Buyouts Levered? The Financial Structure of Private Equity Funds
London School of Economics; Swedish Institute for Financial Research (SIFR)
Stockholm School of Economics; University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); Stockholm School of Economics - Department of Finance
Michael S. Weisbach
Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)
Charles A. Dice Center Working Paper No. 2008-15; Fisher College of Business Working Paper No. 2008-03-014
Journal of Finance, Forthcoming
Private equity funds are important actors in the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to economy-wide availability of credit and investments in bad states outperform investments in good states.
Number of Pages in PDF File: 83
Keywords: LBO funds, Capital Structure, Private Equity, Ex Ante Financing, Ex Post Financing, Incentives in Private Equity
JEL Classification: G32, G23Accepted Paper Series
Date posted: March 12, 2005 ; Last revised: October 28, 2008
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