Leverage and the Performance of Buyouts: (How) Does the Use of Debt Impact Equity Returns?

Zeitschrift für Betriebswirtschaft (ZfB), Forthcoming

Posted: 10 Jan 2012

See all articles by Nico Engel

Nico Engel

Technische Universität München - Center for Entrepreneurial and Financial Studies

Reiner Braun

Technische Universität München (TUM) - TUM School of Management

Ann‐Kristin Achleitner

Technische Universität München - Center for Entrepreneurial and Financial Studies

Date Written: January 10, 2012

Abstract

In this paper we investigate the effects of debt usage on (risk-adjusted) equity returns in private equity-backed buyout transactions. We use a proprietary data set of more than 700 realized European and North American buyouts acquired between 1990 and 2006 to empirically assess theoretical predictions. Our results show a positive relationship between debt levels and equity returns indicating the return-enhancing effects related to leverage. However, our results also provide evidence that it is possible to ‘over-leverage’ a company, i.e. at very high levels of leverage (debt to total capital of approximately 90%) the increased company default risk outweighs the positive effects related to leverage resulting in decreasing equity returns. On the other side, we find no significant relationship between leverage and risk-adjusted equity returns which implies that the return increase through higher debt ratios comes along with increasing risk. In addition, we show that private equity sponsors successfully conduct debt-equity-arbitrage in times of favorable debt market conditions. This implies that these investors successfully time debt markets.

Keywords: private equity, buyout, performance, leverage, debt-equity-arbitrage

JEL Classification: G24, G32

Suggested Citation

Engel, Nico and Braun, Reiner and Achleitner, Ann-Kristin, Leverage and the Performance of Buyouts: (How) Does the Use of Debt Impact Equity Returns? (January 10, 2012). Zeitschrift für Betriebswirtschaft (ZfB), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1982474

Nico Engel (Contact Author)

Technische Universität München - Center for Entrepreneurial and Financial Studies ( email )

Arcisstrasse 21
Munich, DE 80333
Germany

Reiner Braun

Technische Universität München (TUM) - TUM School of Management ( email )

Arcisstr. 21
Munich, Deutschland 80333
Germany
+498928925181 (Phone)
+498928925188 (Fax)

HOME PAGE: http://www.ef.wi.tum.de/

Ann-Kristin Achleitner

Technische Universität München - Center for Entrepreneurial and Financial Studies ( email )

Arcisstr. 21
Munich, D-80290
Germany
+49 89 289 25181 (Phone)

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