An analysis of leveraged buyouts

Financial theory holds that in a perfect market a firm's investment policy will be independent of its capital structure. This dissertation analyzes pre- and post-leveraged buyout firm performance to determine if investment policy is independent of capital structure when a leveraged buyout (LBO) occurs. LBO performance is analyzed over a seven year horizon which allows the determination of both how and why firm performance changes following an LBO. The LBO firm sample includes firms that announced an LBO between January 1, 1982 and December 31, 1987 for which financial information was publicly available.; The empirical results show that firm performance changes following an LBO. An LBO provides a financial incentive to owners through two components: (1) an increase in the net present value of the firm through asset redeployment, and (2) the financial gain afforded by leverage. An LBO provides an attractive way for owners to profit from asset redeployment due to the financial gains made possible by leverage. Thus, capital structure and investment decisions become interdependent when an LBO occurs.; The change to an LBO structure causes a significant increase in financial payments (interest expense plus principal payments). The increase in interest and principal payments requires the firm to redeploy cash flows or generate additional cash flows to meet its financial payment obligations. The additional cash flow is obtained from one or more of the following: (1) division divestitures, (2) improvement in employee productivity, (3) reduced spending on capital expenditures and research and development, (4) less funds invested in working capital, (5) greater utilization of the tax shield afforded to interest payments, and (6) reduced cash dividends. On average, proceeds from division divestitures are found to be the primary source of funds to meet the increased financial payments.; Following an LBO, the firm's investment policy and capital structure become intertwined. The LBO capital structure is a function of collateralizable assets, expected cash flows, and investors' required rates of return.