Finance Brown Bag Seminar
Speaker: Glebs Ivanovs, Goethe University Frankfurt
Topic: What Drives Leverage in Leveraged Buyouts?
The literature on leveraged buyouts (LBOs) reveals that inefficiencies from information asymmetries between lenders and private equity groups (PEGs) can be reduced through relationship building. In contrast to previous studies, we provide evidence that these inefficiencies are also reduced by the PEG's reputational capital. We find that these two alternative channels are crucial drivers of leverage in portfolio companies. We examine a unique sample of 1,524 sponsored LBOs originated in North America and Europe between 1993 and 2009. After controlling for other borrowers' characteristics, macro-economic factors, and the financing contract, we find that, while a one-standard-deviation increase in bank relationship intensity results in 0.058x higher leverage (equivalent to an additional $10 million in debt), a one-standard-deviation increase in PEGs' reputational capital leads to 0.106x higher leverage ($18 million). We conclude that both relationship and reputation are substitute mechanisms in reducing inefficiencies from information asymmetries. Moreover, leverage is primarily driven by the reputational capital of the financial sponsor. The relationship building only matters if a PEG is less reputable, since with increasing reputational capital, PEGs tend to diversify their bank relationships.