Capital Structure & Firm Outcomes: Evidence from Dividend Recapitalizations in Private Equity

Abstract

We study the effect of a large increase in firm leverage. We isolate the independent, causal effect of debt using the setting of private equity-sponsored dividend recapitalizations, where companies take on debt to pay investor returns, and opportunistic responsiveness to credit supply permits a causal design. After accounting for positive selection, higher total debt (84% on average) dramatically increases the chance of financial distress (by 2.4 times the targeted firm mean), in line with Altman-Z calibrations. Dividend recapitalizations increase deal returns but reduce fund returns, possibly reflecting moral hazard. They also reduce employee wages and loan prices for pre-existing creditors.

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