Canadian Investment Review

Leveraged buyouts increase chance of bankruptcy: research

Written by Staff on Tuesday, July 30th, 2019 at 9:59 am

Copyright : Paul Fleet // 123RFLeveraged buyouts have a reputation for creating bankruptcy risk for the company being purchased.

“With the recent wave of private equity-backed leveraged buyouts that are ending in bankruptcy, politicians, regulators and the general public are once again becoming more concerned with these highly levered transactions,” said the paper by Brian Ayash and Mahdi Rastad, both assistant professors at the California State Polytechnic University.

Particularly, the research found that when comparing firms that were subject to leverage buyouts to those in a control group that remained public, approximately 20 per cent of the leverage buyout firms went bankrupt in 10 years compared to only two per cent of the control group.

“Our results suggest that the leveraged capital structure common in these transactions is speculative, disproving the stylized fact that private equity funds target struggling firms and make them more efficient,” the report said. “Rather, our empirical tests suggest that private equity funds acquire healthy firms and increase their probability of default ten-fold. Our research design makes our analysis robust to macroeconomic and industry shocks, and the use of propensity score matched control firms allows for the identification of a causal effect.”

Within the 484 companies studied, 215 were in manufacturing, 87 in services and 84 in retail trade.

Retail trade and construction companies were the most likely to go bankrupt after a leveraged buyout, at a rate of one in three. Wholesale trade, finance, insurance and real estate, meanwhile, were the least likely, the paper found when looking at industries with at least five transactions between 1980 and 2003.

“Given the large number of recent high profile private equity backed LBO bankruptcies, it is difficult for policy makers to ignore the impact of these controversial transactions on their constituents and society as a whole,” the report concluded. “Moreover, given the economic significance of the typical LBO target firm, its bankruptcy not only affects the welfare of its shareholders and lenders, but it also directly impacts the lives of tens of thousands of employees. Finally, while suppliers, customers, local economies, pension funds, state and federal government tax revenues all feel the burden when an LBO company goes under, the partners at the private equity funds do not share the burden.”

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