The Determinants and Dynamics of Capital Structure in Leveraged Buyouts: An Empirical and Theoretical Analysis of Financial Structuring Under Uncertainty and Changing Markets

Abstract

This thesis adds to the limited research on one of the most debt-intensive transaction environments in finance, private equity-backed leveraged buyouts. Through a three-part framework, comprising theoretical dynamic capital structure modeling, empirical econometrics, and practical insights form industry professionals, we examine how leverage, debt ratios, valuations, and equity contributions are shaped by macro-financial conditions, deal characteristics, and sponsor behavior. This study applies both OLS and 2SLS regressions to a uniquely constructed dataset of 1,749 LBO transactions to examine the dynamics of capital structure. By utilizing the three analytical levels we find that i) market-related factors, especially interest rate volatility and credit spreads, are the dominant drivers of opening capital structure outcomes in LBOs, with limited direct influence from traditional firm-level characteristics, ii) loosening credit conditions which relaxes lenders’ risk aversion, emphasizes the option like payoff structure of private equity firms and leads to increased valuations and risk taking from sponsors, iii) tightening credit conditions and increased volatility forces higher equity contributions from private equity sponsors to compensate for decreased risk appetite of lenders, iv) firm-characteristic are a significant determinant of LBO enterprise valuations, and highlights the premium sponsors place on riskier growth-firms relative to larger, more stable targets, and finally v) that capital structure outcomes ultimately reflect an interdependent dynamic between lender constraints, sponsor incentives and valuations, where credit market conditions, and not firm fundamentals, drive leverage levels.