When the going gets tough: Private equity firms’ role as agents and the resolution of financial distress in buyouts

ABSTRACT

Previous research has focused on a private equity (PE) firm’s role as principal in its relationship with an investee, but few studies have looked into their role as agents for their investors. We examine how a PE firm’s relationship as agent for limited partners (LPs) and banks influences its incentives to resolve financial distress in the investee. We examine the effect of PE fundraising reputation, PE fundraising activity, and PE bank affiliation on the likelihood of a financially distressed buyout ending in bankruptcy. We build a unique data set of 338 distressed buyouts in the United Kingdom to test our hypotheses.

KEYWORDS:

• Private equity
• buyouts
• distress
• agency theory
• signaling theory

Acknowledgments

The paper has benefited from feedback received at the Academy of Management meetings, at Babson College Entrepreneurship Research Conference, and at a research seminar at St. Gallen University. We would like to acknowledge Bart Van Hoe who contributed to the data collection.

Notes

¹ In English law, the term “bankruptcy” is reserved for individuals only; the word “insolvency” applies to corporations. The term “bankruptcy” is used in line with international practice.

² For robustness testing, we also narrowed the fundraising period to one year prior to the year of the first investment. Results were similar but less significant.