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Why are Buyouts Levered? The Financial Structure of Private Equity Funds

83 Pages Posted: 12 Mar 2005 Last revised: 28 Oct 2008

Ulf Axelson

London School of Economics; Swedish Institute for Financial Research (SIFR)

Per Strömberg

Swedish House of Finance

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)

Abstract

Private equity funds are important actors in the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to economy-wide availability of credit and investments in bad states outperform investments in good states.

Keywords: LBO funds, Capital Structure, Private Equity, Ex Ante Financing, Ex Post Financing, Incentives in Private Equity

JEL Classification: G32, G23

Suggested Citation

Axelson, Ulf and Strömberg, Per and Weisbach, Michael S., Why are Buyouts Levered? The Financial Structure of Private Equity Funds. Charles A. Dice Center Working Paper No. 2008-15; Fisher College of Business Working Paper No. 2008-03-014; Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=676546

Ulf Axelson (Contact Author)

London School of Economics ( email )

United Kingdom

Swedish Institute for Financial Research (SIFR) ( email )

Drottninggatan 89
SE-113 59 Stockholm, SE-113 60
Sweden

Per Stromberg

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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