The Determinants of Leverage Ratios and Loan Spreads in European Leveraged Buyouts

Abstract

The purpose of this thesis is to investigate how leverage ratios and loan spreads are determined in European leveraged buyout (LBO) transactions. Due to the nature of LBOs, the high amount of debt capital that is involved in the transaction greatly affects the financial flexibility of a target company. Although existing literature offers various explanations for the drivers of leverage ratios and loan pricing, the findings are contradicting and cannot be entirely interpreted to the recent surge of European LBOs. Thus, it is crucial to understand and identify the underlying determinants of capital structures and loan spreads in the overheating leveraged loan market. The data for European LBO transactions stems from early 2011 to mid-2018, covering the recent surge of LBO activity with 123 transactions and 253 loan tranches across 19 countries. OLS regressions are used as a methodology for conducting the research on leverage ratios and loan spreads, with a set of explanatory variables to control for company and loan characteristics, as well as the debt market conditions. The findings of the study show that leverage ratios are not determined by the classical capital structure determinants nor the debt market conditions. Rather, in line with the trade-off theory, the profitability of a target company drives the capital structure decision. Additionally, more experienced and reputed private equity sponsors use more leverage to finance transactions. The results also confirm that institutional loans and covenant lite loans have pushed leverage ratios higher. On the other hand, loan spreads are determined by the target company size and prevailing debt market conditions. The effect of economy-wide changes in the debt markets is greater for bank loans than for institutional loans. More interestingly, the evidence shows that higher leverage levels are associated with cheaper debt. Finally, loan terms play a crucial role in determining the cost of debt. Target companies are able to reduce their lending costs by issuing larger debt amounts whereas longer maturities are compensated with higher spreads.