Economics Of Buyouts
This dissertation consists of three parts. The first two, while answering important questions about investment and cpital structure in their own right, develop key elements to the model that is used in the final part of the paper that addresses the main question of my work at Wharton - how private equity (PE) firms create value.Empirical analysis of a sample of companies with PE ownership in the UK shows that PE firms act as deep-pocket investors for their portfolio companies, rescuing them if they fall in financial distress. In contrast, external financing is expensive for companies without PE- ownership in financial distress. The paper builds a model that shows how companies form rational expectations about the costs of financial distress, and how these expectations affect ex-ante policies. The model explains the empirically-observed differences in how companies with and without PE-ownership invest, pay dividends, and issue debt. In particular, the model quantitatively explains the difference in leverage of companies with and without PE-ownership. The model shows that greater tax-shield benefits and superior growth of PE-backed companies can explain 6.4% of the abnormal return of PE firms. The conclusion that follows from the paper, however, is that abnormal returns PE firms cannot be replicated by other investors.