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Why Are Buyouts Levered? The Financial Structure of Private Equity Funds

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  • Axelson, Ulf

    (Stockholm School of Economics and SIFR)

  • Stromberg, Per

    (Stockholm School of Economics and SIFR)

  • Weisbach, Michael S.

    (Ohio State U)

Abstract

Private equity funds are important actors in the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to economy-wide availability of credit and investments in bad states outperform investments in good states.

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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2008-15.

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Date of creation: Sep 2008
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Handle: RePEc:ecl:ohidic:2008-15

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