Lender Control and the Role of Private Equity Group Reputation in Buyout Financing

45 Pages Posted: 27 Mar 2008

See all articles by Cem Demiroglu

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: November 1, 2007

Abstract

In this paper, we examine whether the reputation of the acquiring private equity group (PEG) is related to the financing structure, loan contract terms, and valuation of LBOs. Using a sample of 181 public-to-private leveraged buyouts (LBOs) completed during the January 1, 1997 to August 15, 2007 period, we find that buyouts sponsored by high reputation funds pay narrower loan spreads, have fewer and less restrictive financial loan covenants, use less traditional bank debt, and borrow more and at a lower cost from institutional loan markets. In addition, PEG reputation is positively related to the amount of leverage used to finance the buyout. While we find that reputation is related to the amount of leverage used, and leverage is significantly related to buyout pricing, we do not find any direct effect of reputation on buyout valuations. We also find that deals sponsored by high reputation PEGs are less likely to experience financial distress or bankruptcy ex-post. The evidence is consistent with the hypothesis that deals involving reputable PEGs are perceived as less risky by creditors because reputable PEGs are more skillful in selecting and monitoring investments or because reputation serves to mitigate the agency costs of debt and thus lowers the need for bank monitoring and control. We also find that macroeconomic conditions (e.g. credit risk spreads), growth prospects, ex-ante risk, and deal size also impact buyout financing terms and valuations. Overall, our results suggest that the increase in leverage and the decline in both the proportion of bank debt financing and the restrictiveness of covenants in recent deals reflect in part the involvement of experienced PEGs in recent buyouts.

Keywords: LBO, financing, covenant, private equity, reputation

JEL Classification: G21, G24, G32, G34

Suggested Citation

Demiroglu, Cem and James, Christopher M., Lender Control and the Role of Private Equity Group Reputation in Buyout Financing (November 1, 2007). Available at SSRN: https://ssrn.com/abstract=1106378 or http://dx.doi.org/10.2139/ssrn.1106378

Cem Demiroglu (Contact Author)

Koc University, College of Administrative Sciences and Economics ( email )

Koc University
Sariyer
Istanbul, 34450
Turkey
90-212-338-1620 (Phone)
90-212-338-1653 (Fax)

HOME PAGE: http://https://sites.google.com/site/cemdemiroglu/

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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