Broken Promises: The Role of Reputation in Private Equity Contracting and Strategic Default

51 Pages Posted: 23 Jan 2010 Last revised: 11 Sep 2012

Matthew D. Cain

U.S. Securities and Exchange Commission

Steven Davidoff Solomon

University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy

Antonio J. Macias

Baylor University

Date Written: September 2012

Abstract

This paper examines reputation and contract design in private equity acquisitions. We use a novel dataset of both completed and terminated private equity buyouts from 2004 through 2010. We find that private equity firms and targets rely on reputation to fill intentional contractual gaps. During the financial crisis private equity firms complete uneconomic, pre-agreed takeovers up to the point when estimated buyout losses rise to at least 7% of sponsors’ fund sizes, or $200 to $400 million in nominal values. Target firms are willing to engage with defaulting private equity firms in future transactions but they penalize these firms by demanding significantly larger contract nonperformance penalties. We conclude that both reputation and explicit contracting can play important and interrelated roles in private equity and complex business relationships generally.

Keywords: private equity, reputation, contracting, termination

JEL Classification: G34, G30, K12, L14

Suggested Citation

Cain, Matthew D. and Davidoff Solomon, Steven and Macias, Antonio J., Broken Promises: The Role of Reputation in Private Equity Contracting and Strategic Default (September 2012). AFA 2012 Chicago Meetings. Available at SSRN: https://ssrn.com/abstract=1540000 or http://dx.doi.org/10.2139/ssrn.1540000

Matthew D. Cain (Contact Author)

U.S. Securities and Exchange Commission ( email )

United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
United States

Steven Davidoff Solomon

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

University of California, Berkeley - Berkeley Center for Law, Business and the Economy ( email )

Berkeley, CA 94720-7200

Antonio J. Macias

Baylor University ( email )

Waco, TX 76798
United States

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