Why are Buyouts Levered: The Financial Structure of Private Equity Funds

Ulf Axelson, Per Stromberg and Michael Weisbach

No 12826, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper presents a model of the financial structure of private equity firms. In the model, the general partner of the firm encounters a sequence of deals over time where the exact quality of each deal cannot be credibly communicated to investors. We show that the optimal financing arrangement is consistent with a number of characteristics of the private equity industry. First, the firm should be financed by a combination of fund capital raised before deals are encountered, and capital that is raised to finance a specific deal. Second, the fund investors' claim on fund cash flow is a combination of debt and levered equity, while the general partner receives a claim similar to the carry contracts received by real-world practitioners. Third, the fund will be set up in a manner similar to that observed in practice, with investments pooled within a fund, decision rights over investments held by the general partner, and limits set in partnership agreements on the size of particular investments. Fourth, the model suggests that incentives will lead to overinvestment in good states of the world and underinvestment in bad states, so that the natural industry cycles will be multiplied. Fifth, investments made in recessions will on average outperform investments made in booms.

JEL-codes: G31 G32 (search for similar items in EconPapers)
Date: 2007-01
New Economics Papers: this item is included in nep-cfn and nep-fmk
Note: CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Published as Ulf Axelson & Per Strömberg & Michael S. Weisbach, 2009. "Why Are Buyouts Levered? The Financial Structure of Private Equity Funds," Journal of Finance, American Finance Association, vol. 64(4), pages 1549-1582, 08.

Downloads: (external link)
http://www.nber.org/papers/w12826.pdf (application/pdf)

Related works:
Journal Article: Why Are Buyouts Levered? The Financial Structure of Private Equity Funds (2009)
Working Paper: Why Are Buyouts Levered? The Financial Structure of Private Equity Funds (2008)
Working Paper: Why are Buyouts Levered? The Financial Structure of Private Equity Funds (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:12826

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w12826

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().