Environmental and social incidents and misvaluation-driven leveraged buyouts

Abstract

This study examines how private equity (PE) firms incorporate environmental and social (E&S) factors into investment decisions, particularly in the context of leveraged buyouts (LBOs). Using a global dataset of public firms from 2007 to 2020, we analyse the relationship between firm-level E&S incidents and the likelihood of a subsequent PE acquisition. We further assess whether PE firms committed to responsible investing – proxied by their signatory status to the UN Principles for Responsible Investment (PRI) – exhibit distinct investment behaviour compared to non-signatories. Our findings indicate that firms experiencing E&S incidents, particularly of lower severity, are more likely to be targeted for LBOs, primarily due to a valuation channel, whereby such incidents lead to temporary undervaluation. This effect is more pronounced among non-PRI signatories, while PRI-affiliated PE firms demonstrate greater selectivity, aligning investment decisions with responsible investment principles. These results contribute to the literature on sustainable finance and the integration of ESG considerations in PE investment strategies.