Does Private Equity Over-Lever Portfolio Companies?

61 Pages Posted: 10 Aug 2021 Last revised: 16 Dec 2022

See all articles by Sharjil Haque

Sharjil Haque

Board of Governors of the Federal Reserve System

Date Written: October 18, 2020


Detractors have warned that Private Equity (PE) funds tend to over-lever their portfolio companies because of an option-like payoff, building up default risk and debt overhang. This paper argues PE-ownership leads to substantially higher levels of optimal (value-maximizing) leverage, by reducing the expected cost of financial distress. Using data from a large sample of PE buyouts, I estimate a dynamic trade-off model where leverage is chosen by the PE investor. The model is able to explain both the level and change in leverage documented empirically following buyouts. The increase in optimal leverage is driven primarily by a reduction in the portfolio company's asset volatility and, to a lesser extent, an increase in asset return. Counterfactual analysis shows significant loss in firm value if PE sub-optimally chose lower leverage. Consistent with lower asset volatility, additional tests show PE-backed firms experience lower volatility of sales and receive greater equity injections for distress resolution, compared to non PE-backed firms. Overall, my findings broaden our understanding of factors that drive buyout leverage.

Keywords: Private Equity Funds, Optimal Capital Structure, Over-Leveraged, Distance-To-Default, Systemic Risk, Distress Cost

JEL Classification: D21, D22, E50, G13, G32, G33

Suggested Citation

Haque, Sharjil, Does Private Equity Over-Lever Portfolio Companies? (October 18, 2020). Available at SSRN: or

Sharjil Haque (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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