Private Equity Firms’ Reputational Concerns and the Costs of Debt Financing

Abstract

A popular view is that private equity (PE) firms tend to expropriate other stakeholders of their portfolio companies. Bonds offered during 1992–2011 by companies after their initial public offerings (IPOs) do not reflect this view. We find that yield spreads on bonds offered by PE-backed companies are, on average, 70 basis points lower, holding other things constant. We also find that PE-backed companies have more conservative investment and dividend policies after bond offerings compared with non-PE-backed companies. These results suggest that PE firms’ reputational concerns dominate their wealth expropriation incentives and help their portfolio companies reduce the costs of debt.

A theory of LBO activity based on repeated debt-equity conflicts

“…Moreover, repeated deal making amplifies the effect of credit supply on LBO activity. Shocks to the availability of credit, such as rapid development of the junk bond market in the 1980s (Kaplan and Stein, 1993) and growth in securitization in 2004(Shivdasani and Wang, 2011, are amplified: By increasing expectations of future activity (parameter γ), such shocks make it easier for PE firms to commit to not diverting value, leading to a higher willingness to pay for targets and more deals. private equity firms.…”

Relationship Banking and Loan Syndicate Structure: The Role of Private Equity Sponsors

“…A PE firm would become more recognized as they repeatedly access the loan market. A PE firm with good reputation could also mitigate information asymmetry problems of the borrowing company (Demiroglu and James, ; Huang, Ritter and Zhang, ). We use the natural log of total dollar amount of borrowing by a PE firm in the past five years to represent its reputation in the loan market and control for it in our regressions.…”

“…Table also reports the summary statistics of key borrower‐specific characteristics at the time of loan origination. With an average age of 18.26 years, the companies in our full sample tend to be younger than the bond issuers in Huang, Ritter and Zhang (). This is consistent with Diamond (), who reports that younger companies tend to use private bank debt.…”

“…The literature suggests that information asymmetries 1 PE firms are active players in the syndicated loans market and build relationships with banks (Ivashina and Kovner, 2011). PE firms often retain influential equity stakes and/or serve on the boards of their portfolio companies in the first several years after the companies go public (Cao and Lerner, 2009;Huang, Ritter and Zhang, 2016). PE-sponsored IPOs include both reversed leveraged buyouts (RLBOs) and IPOs of private companies that were bought by PE firms and did not go through a public-to-private transition.…”

“…3 PE firms have significant equity stakes in an increasing number of U.S. companies. The fraction of U.S. IPOs backed by PE firms has increased substantially from the 1990s to the 2000s (Huang, Ritter and Zhang, 2016). PE-backed IPOs tend to have better stock and operating performance than other IPOs (e.g., Cao and Lerner, 2009;Guo, Hotchkiss and Song, 2011).…”