Leveraged Buy Out: Does the Arrival of New Targets Increase the Agents' Incentives?

Abstract

This paper studies the financial capital structure in Leveraged Buy Out (LBO) acquisitions. It analyzes how the arrival of new targets improves the agents’ incentives when there is asymmetric information. The entrepreneur and the LBO investor exert unobservable efforts to enhance the productivity of their project. We show that there are no debt-equity contracts that induce the entrepreneur and the LBO investor to provide the first-best levels of efforts. The decision of the LBO fund to exit prematurely the entrepreneur’s project increases the agents’ incentives. We also find that the entrepreneur’s incentives increase with the amount of debt and when the LBO investor promises her the whole compensation cost.