Leverage and pricing of debt in LBOs |
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| Authors: | Paolo Colla Filippo Ippolito Hannes F Wagner |
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| Institution: | 1. University of Illinois Urbana-Champaign, Department of Finance, 515 E. Gregory Drive, Champaign, IL 61820, USA.;2. Boston University Questrom School of Business, Department of Finance, 595 Commonwealth Avenue, Boston, MA 02215, USA;3. Vienna University of Economics and Business, Department of Finance, Accounting and Statistics, Welthandelsplatz 1, 1020 Vienna, Austria.;1. National Sun Yat-sen University, Department of Finance, College of Management, 70. Lianhai Rd., Kaohsiung 80424, Taiwan;2. National Tsing Hua University, Department of Quantitative Finance, College of Technology Management, No. 101, Section 2, Kuang-Fu Road, Hsinchu, Taiwan 30013;3. University of North Carolina at Charlotte, Department of Finance, Belk College of Business, Charlotte, NC 28223, USA;1. Department of Accounting, School of Business, Aalto University, P.O. Box 21210, FI-00076 Aalto, Finland;2. CentER, Tilburg University, P.O. Box 90153, 5000 LE Tilburg, The Netherlands;1. Universitat Pompeu Fabra, Spain;2. Barcelona GSE, Spain;3. CEPR, UK;4. Federal Reserve Bank of Boston, 600 Atlantic Avenue, T-905, Boston, MA 02210, USA;5. Federal Reserve Board, United States |
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| Abstract: | We show that the structure and pricing of debt in LBOs mostly depend on a single characteristic of the target firm, pre-LBO profitability. We find a positive relationship between pre-LBO profitability and deal leverage that is consistent with a dynamic trade-off theory of capital structure in the presence of adjustment costs. We argue that the wide range of debt tranches used in LBO financing can be folded into two main categories, senior and junior debt, where the pricing of senior and junior debt depends on their relative use and on bankruptcy risk. Our evidence also suggests that senior lenders oversupply cheap credit during hot buyout markets. |
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