The Private Equity Advantage: Leveraged Buyout Firms and Relationship Banking

This article examines the impact of leveraged buyout firms' bank relationships on the terms of their syndicated loans. We examine a sample of 1,590 loans financing private equity sponsored leveraged buyouts between 1993 and 2005, and find that private equity firms' bank relationships are an important factor in cross-sectional variation in the loan interest rate and covenant structure. Our results indicate that bank relationships formed through repeated interactions reduce inefficiencies from information asymmetry and allow leveraged buyouts sponsored by private equity firms to occur on favorable loan terms. A one-standard-deviation increase in bank relationship strength is associated with an 8-basis-point (3%) decrease in the spread and a 0.21-basis-point (4%) increase in the maximum debt to EBITDA covenant. We also find evidence that banks price loans to cross-sell other fee business. A one-standard-deviation increase in both bank relationship strength and cross-selling potential translates into as much as a 4-percentage-point increase in equity return to the leveraged buyout firm. (JEL G20, G21, G23, G24, G32)