Exit Routes in LBO : Does Leverage Solve Risk-Taking Problem?

The current paper studies the financial structure in buyout firms under moral hazard due to unobservable efforts and an excessive risk-taking. The choice of the exit route may lead to agency conflicts between the entrepreneur and the Leveraged Buyout (LBO) firm: the former may take very risky decisions to increase the probability of IPO exit. If the target is going public, he gets a non-transferable and private benefit. The opportunistic behavior of the entrepreneur decreases the probability of sale exit, the preferred exit route of the LBO firm. Without moral hazard, there are many ways to finance the project and the two agents exert strictly positive efforts. With moral hazard, the entrepreneur, the LBO firm and the bank must jointly finance the buyout. Financing the project through standard debt-equity contracts does not implement the first best solution. Only a set of projects can be financed through both the LBO fund and the bank at the macroeconomic level. If the entrepreneur is not wealthy enough, her project is not undertaken