The Evolution of Buyout Pricing and Financial Structure

This paper presents evidence on systematic changes in the pricing and financial structure of 124 large management buyouts completed between 1980 and 1989. We find that over tine (1) prices increased relative to current cash flows with no accompanying decrease in risk or increase in projected future cash flows; (2) required bank principal repayments accelerated, leading to sharply lower ratios of cash flow to total debt obligations; (3) private subordinated debt was replaced by public debt while the use of strip-financing techniques declined; and (4) management teams invested a smaller fraction of their net worth in post-buyout equity. These patterns of buyout prices and structures suggest that based on ex ante data, one could have expected lower returns and more frequent financial distress in later buyouts. Preliminary post-buyout evidence is consistent with this interpretation.