Does the Reputation of a Private Equity Group Break the Bank-Dependence of its Portfolio Company?

Abstract

We investigate the impact of the reputation of a private equity group (PEG) on financing costs in leveraged buyouts (LBOs). PEGs with a strong reputation have superior selection abilities and may be able to obtain cheaper LBO loans due to their role in limiting moral hazard or their impact on lenders’ bargaining power in loan contract negotiations. We examine a sample of 4,111 credit facilities within 1,524 PEG-sponsored LBO loans in North America and Europe between 1993 and 2009. After controlling for other borrowers’ characteristics, the financing contract, and other factors, we find that PEGs’ reputation indeed lowers financing costs. The size of the effect depends crucially on the chosen syndicate structure. The effect on credit spreads is much stronger when the loan syndicate is highly concentrated. The literature reveals that concentrated syndicate structures are chosen by less transparent and more bank-dependent borrowers. We therefore conclude that well-reputed PEGs reduce financing costs because they are able to alleviate the effects of information monopolies that arise when asymmetric information limits the degree of competition between financing banks.

Keywords: Private Equity, Buyouts, Portfolio Company, LBO Debt, Credit Terms, Reputation, Banks

JEL Classification: G21, G23, G24, G32