Do private equity owners increase risk of financial distress and bankruptcy?

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW.Download this ZEW Discussion Paper from our ftp server:http://ftp.zew.de/pub/zew-docs/dp/dp11076.pdf Non-technical summaryThere is some controversy regarding the key sources of success in the private equity business model and on how this business model affects the portfolio companies. Does this success come from value creation or from value transfer? On the one hand, scholars agree that private equity investors create value by implementing a superior corporate governance mechanism and due to the disciplining role of additional debt resulting from the transaction financing. On the other hand, some scholars and especially some politicians point out potential negative effects of increased indebtedness of portfolio companies and argue that private equity investors rather transfer value from stakeholders or taxpayers than create it. Political debates are often led by concerns about harmful effects of excessive debt levels and higher bankruptcy risks in companies which undergo buyout transactions.We investigate financial distress risks of European companies around their buyout event in the period 2000 -2008. In addition, we analyze whether private equity-backed companies go bankrupt more often than comparable companies without private equity investments. Our paper suggests that private equity investors select companies which are less financially distressed than comparable companies prior to the transaction and that the distress risks increase after the buyout. However, the distress risk in private equity-backed companies does not exceed the distress risk in comparable companies three years after the buyout. Despite this risk increase, private equity-backed companies do not suffer from higher bankruptcy rates than the control group. Even those companies subject to buyouts in years with favorable debt market conditions do not suffer from higher bankruptcy rates than other private equity-backed and non-private equity-backed companies. Our results further lend support to the hypothesis that firms backed by experienced private equity investors achieve even lower bankruptcy probability compared to firms backed by inexperienced investors and to firms without private equity investments. Experienced investors seem to be better able to manage distress risks than their inexperienced counterparts. In addition, we analyze whether buyout companies go bankrupt more often than comparable non-buyout companies. Our paper suggests that private equity investors select companies which are ...

Private Equity, Buy‐outs and Insolvency Risk

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Determinants and consequences of financial distress: review of the empirical literature

“… Private equity (PE) investors have often been blamed for exposing firms to distress as they increase the proportion of debt to award themselves with special dividends, and the increased debt level, in turn, increases the likelihood of financial distress (Kaplan and Stein, ). Interestingly, using a sample of European companies during 2000–2008, Tykvová and Borell () find the bankruptcy rates of the buyout companies backed by experienced PE investors were even lower than those of comparable non‐buyout companies. …”

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