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The opportunity cost of capital of US buyouts

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Author Info
Groh, Alexander P. () (IESE Business School)
Gottschalg, Oliver (HEC School of Management)
Abstract

This paper addresses the problem of accurately determining buyout opportunity cost of capital for performance analyses. It draws on a unique and proprietary set of data on 133 United States buyouts between 1984 and 2004. For each buyout, we determine a public market equivalent that matches the buyout in timing and systematic risk. We show that under realistic mimicking conditions, the average opportunity cost of capital is below the commonly used benchmark S&P 500. The surprising result has a simple explanation: ex post, many of the transactions mimicking the buyouts would have defaulted in the public market. Only under relaxed assumptions, is the average opportunity cost of capital close to the average index return. Our sensitivity analyses highlight the need for a comprehensive risk adjustment that considers both operating risk and leverage risk for an accurate assessment of buyout performance. This finding is particularly important as existing literature on this topic tends to rely on benchmarks without a proper risk adjustment.

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Paper provided by IESE Business School in its series IESE Research Papers with number D/780.

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Length: 41 pages
Date of creation: 05 Feb 2009
Date of revision:
Handle: RePEc:ebg:iesewp:d-0780

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Related research
Keywords: Private Equity; Risk-Adjusted Performance; Buyout; Benchmarking Alternative Assets;

Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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