A Theory of LBO Activity Based on Repeated Debt-Equity Conflicts

52 Pages Posted: 16 Apr 2013 Last revised: 8 Aug 2015

See all articles by Andrey Malenko

Andrey Malenko

MIT Sloan School of Management

Nadya Malenko

Boston College - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: September 1, 2015


We develop a theory of leveraged buyout (LBO) activity based on two elements: the ability of private equity-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 they 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.

Keywords: Private equity, leveraged buyout, LBO, reputation, club deals, externalities, capital structure, debt-equity conflicts

JEL Classification: G23, G32, G34, D44

Suggested Citation

Malenko, Andrey and Malenko, Nadya, A Theory of LBO Activity Based on Repeated Debt-Equity Conflicts (September 1, 2015). Journal of Financial Economics (JFE), 117 (3), 607-627, September 2015. Available at SSRN: https://ssrn.com/abstract=2251169 or http://dx.doi.org/10.2139/ssrn.2251169

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 - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

European Corporate Governance Institute (ECGI) ( email )

B-1050 Brussels

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