The Levered Returns of Leveraged Buyouts : The Impact of Competition

This paper investigates the relationship between leverage and returns in private equity buyout transactions. In contrast to the predictions of traditional capital structure theory, we find that transactions financed with large amounts of debt are associated higher transaction prices and lower returns to private equity sponsors. Consistent with the view that easy credit amplifies the intensity of bidding for deals, these relationships hold only when private equity buyers face competition from other funds, such as in deals sourced from investment bank auctions. Our results are distinct from changes in deal prices driven by private equity fundraising and the results are robust to alternative, plausibly exogenous, proxies for the competitiveness of deals. Finally, we show that the choice to pursue auction deals in particularly loose credit markets, when expected returns are low, is positively related to proxies for agency conflicts between fund managers and fund investors