Industry concentrations and cyclicality of cash flows in leveraged buyouts

Leveraged buyouts (LBOs) became increasingly popular in the 1980s, as investment banking firms gained proficiency at arranging them and investors channeled their money into junk bond funds in expectation of high returns. The level of corporate debt rose from $965 billion in 1982 to $1.8 trillion in...

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Bibliographic Details
Published in:American business review 1997-01, Vol.15 (1), p.15
Main Authors: Epplin, Maryellen P, Pourjalali, Hamid
Format: Article
Language:English
Subjects:
Business cycles
Cash flow
Corporate debt
Debt service
Debt to equity ratio
GNP
Gross National Product
Industrial concentration
LBO
Leveraged buyouts
Regression analysis
Studies
Tax Reform Act 1986-US
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Summary:Leveraged buyouts (LBOs) became increasingly popular in the 1980s, as investment banking firms gained proficiency at arranging them and investors channeled their money into junk bond funds in expectation of high returns. The level of corporate debt rose from $965 billion in 1982 to $1.8 trillion in 1988, representing an increase from 32% to 37% of the US gross national product in those six years. Many LBO entities later seek protection from their creditors under Chapter 11 bankruptcy because of their inability to service the new debt loads while continuing operations. Two factors that are likely to determine how well a firm will be able to perform after a buyout are the cyclicality of its cash flows and the level of competition within the firms' industry. Another factor impacting premiums paid by LBOs was the 1986 Tax Reform Act. An examination of the companies that ere in involved in LBOs from 1980-1987 found that the greater the level of concentration within an industry, the more likely that the premium paid will be lower. This is because in a highly competitive industry, the true value of the acquired entity is more likely to be known. It was also found that firms did not plan for economic downturns when assessing their cash flows to meet debt service.
ISSN:0743-2348