Download This PaperThe Structure of Leveraged Buyouts and the Free-Rider Problem *
Swedish House of Finance Research Paper No. 20-9
European Corporate Governance Institute – Finance Working Paper 698/2020
Review of Financial Studies, forthcoming
83 Pages Posted: 26 Mar 2020 Last revised: 1 Jan 2026
There are 2 versions of this paper
The Structure of Leveraged Buyouts and the Free-Rider Problem *
The Social Value of Debt in the Market for Corporate Control
Date Written: September 7, 2023
Abstract
We study the structure of public firm buyouts in a model that features both the Berle-Means problem (lack of incentives) and the Grossman-Hart problem (holdout). We find that bootstrapping, debt in excess of funding needs, and upfront fees to bidders are socially optimal and increase buyout premiums. These elements make LBO financing tantamount to a "management contract" arranged by an outside manager to receive cash and incentives to manage a firm-except the cash is funded by excess debt imposed on the firm. Our model also rationalizes why PE firms collect fees from their equity partnerships and directly from target firms.
Keywords: Leveraged buyouts, bootstrap acquisitions, tender offers, free-rider problem, debt overhang, private equity
JEL Classification: G34, G32
Suggested Citation: Suggested Citation
European Corporate Governance Institute (ECGI)
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Samuel Lee (Contact Author)
Santa Clara University - Leavey School of Business
500 El Camino Real
Santa Clara, CA California 95053
United States