Leverage and Pricing in Buyouts: An Empirical Analysis

I recently presented my paper Leverage and Pricing in Buyouts: An Empirical Analysis, which is co-written with Ulf Axelson, Tim Jenkinson and Per Strömberg, at the Law, Economics and Organizations seminar, here at Harvard Law School.

This paper provides an empirical analysis of the financial structure of large recent buyouts. We collect detailed information of the financings of 153 large buyouts (averaging over $1 billion in enterprise value). We document the manner in which these important transactions are financed. In addition, we compare the firms acquired by private equity funds to comparable firms that are publicly traded. Buyouts are executed by knowledgeable professionals (the general partners (GPs) of the private equity funds) with strong incentives, who utilize sophisticated financial structures designed to maximize value by optimizing on a number of margins.

If we presume that GPs optimize capital structure at the time of the acquisition, then this capital structure provides a benchmark for understanding optimal capital structure in public firms. Lastly, we consider the relation between leverage and transaction multiples, and try to estimate the extent to which the ability of debt markets to provide financing impacts the pricing of deals.

The financial structure that private equity firms choose for their portfolio companies is radically different from that observed for comparably firms quoted on public equity markets. Indeed, a reasonably summary of the differences we observe would be to view them as the inverse of each other. We find that buyout leverage is cross-sectionally unrelated to the leverage of matched public firms, whether we measure leverage as the ratio of debt to enterprise value or by debt as a multiple of cash flow – as proxied by earnings before interest, taxes, depreciation and amortization (EBITDA).

Leverage appears to be largely driven by other factors than what explains leverage in public firms. In particular, the economy-wide cost of borrowing seems to drive leverage. Prices paid in buyouts are related to the prices observed for matched firms in the public market, but are also strongly affected by the economy-wide cost of borrowing. These results are consistent with a view in which the availability of financing impacts booms and busts in the private equity market.

The full paper is available for download here.