The Opportunity Cost of Capital of US Buyouts

65 Pages Posted: 16 Jan 2006 Last revised: 7 Jun 2009

See all articles by Alexander Peter Groh

Alexander Peter Groh

EMLYON Business School

Oliver Gottschalg

HEC Paris - Strategy & Business Policy

Multiple version iconThere are 3 versions of this paper

Date Written: March 3, 2009

Abstract

This paper addresses the problem to accurately determine buyout opportunity cost of capital for performance analyses. It draws on a unique and proprietary set of data on 133 US buyouts between 1984 and 2004. For each of them, we determine a public market equivalent that matches it with respect to its timing and its systematic risk. We show that under realistic mimicking conditions, the average opportunity cost of capital is below the commonly used benchmark S&P 500. The surprising result has a simple explanation: ex post, many of the transactions mimicking the buyouts would have defaulted in the public market. Only under perfect market assumptions is the average opportunity cost of capital close to the average index return. Our sensitivity analyses highlight the necessity of a comprehensive risk-adjustment that considers both operating risk and leverage risk for an accurate assessment of buyout performance. This finding is particularly important as existing literature on that topic tends to rely on benchmarks without a proper risk-adjustment.

Keywords: Private Equity, Risk-Adjusted Performance, Buyout, Benchmarking Alternative Assets

JEL Classification: G11, G24, G32

Suggested Citation

Groh, Alexander Peter and Gottschalg, Oliver, The Opportunity Cost of Capital of US Buyouts (March 3, 2009). Available at SSRN: https://ssrn.com/abstract=876273 or http://dx.doi.org/10.2139/ssrn.876273

Alexander Peter Groh (Contact Author)

EMLYON Business School ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

Oliver Gottschalg

HEC Paris - Strategy & Business Policy ( email )

Jouy-en-Josas Cedex, 78351
France

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