Does Private Equity Over-Lever Portfolio Companies?

Abstract

This paper develops a dynamic trade-off model where a firm’s capital structure and default decisions are made by the PE fund manager. PE-ownership can endogenously change tax benefits of debt and expected cost of financial distress though differences in (i) asset volatility (ii) expected future return and (iii) deadweight bankruptcy costs. Key model parameters are estimated using balance sheet data from a large sample of PE-sponsored leveraged buyouts (LBO). I find the estimated model is able to explain both the level and change in leverage ratios documented empirically following LBOs, driven primarily by changes in the portfolio company hypothesized above.

Author

Sharjil M. Haque, UNC Kenan-Flagler Business School