Global Economic Intersection
Advertisement
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
Global Economic Intersection
No Result
View All Result

What Drives Buyout Booms And Busts?

admin by admin
June 1, 2015
in Uncategorized
0
0
SHARES
0
VIEWS
Share on FacebookShare on Twitter

by Valentin Haddad, Erik Loualiche, and Matthew Plosser – Liberty Street Economics, Federal Reserve Bank of New York

Buyout activity by financial investors fluctuates substantially over time. In the United States, peak years result in close to one hundred public-to-private buyout transactions and trough years in as few as ten. The typical buyout is primarily funded by debt, hence the term “leveraged buyout” (or LBO). As a result, analysis of buyout fluctuations has focused on the availability and cost of debt financing.


However, in a recent staff report, we find that the overall cost of capital, rather than debt alone, is the primary driver of buyout activity. We argue that it is the common changes in both the cost of debt and the cost of equity – the aggregate risk premium – that are the source of booms and busts in buyout activity.

Why should the risk premium matter?

Prior research suggests buyouts are an investment in improved management of a firm. These management improvements in turn increase cash-flow growth. If we examine a simple one-period present valuecalculation, we can see the value of an investment equals the incremental cash flows, CF, less the cost of servicing incremental debt, D, at an interest rate of rd, discounted by a discount rate, re:

Equations

The greater the present value, PV, the more profitable the deal and the more likely it is to be undertaken. We argue that changes in the overall cost of capital, both re and rd, rather than the cost of debt alone are the primary determinants of deal activity. When the cost of capital is low, not only is debt financing cheap (low rd), but the discount rate for buyout investors,re, is also low, resulting in higher present values and more deals. Therefore, we contend booms commonly attributed solely to lower cost of debt are a result of lower costs of financing more generally.

In addition to increasing the cash-flow of a firm, a buyout transaction creates a relatively illiquid investment. Buyout investments typically last three to five years and are not as easily sold as investments in similar public firms. In our paper, we demonstrate that the cost of being illiquid is also greater when the risk premium is high. Hence, a high risk premium not only decreases the present value of cash-flow improvements, but it also increases the costs of making illiquid investments like buyouts.

What is the evidence?

To demonstrate the importance of the overall risk premium rather than debt-related factors we use a measure of the equity risk premium. The details on measuring that premium are in our paper, but the intuition is that we are essentially estimating expected stock market returns. When expected returns are high, market participants demand more return to take on risk. Whereas when expected returns are low, they demand less compensation for holding risk, meaning their risk premium is lower.

The chart below plots the quarterly number of U.S. public-to-private deals along with our measure of the equity risk premium. There are several sustained booms in the number of buyout deals: the late 1980s, the turn of the millennium, the mid 2000s, and a modest rebound after the recent financial crisis. Three of these booms are accompanied by a decline in the risk premium, consistent with our story. Likewise, the sustained drought of buyout activity in the early 1990s corresponds to a persistent and high risk premium.

Buyout activity and the risk premium

Going a step further, we test the risk premium’s ability to explain time variation in buyout activity versus commonly used credit market factors. In these tests we not only want to know whether the risk premium is negatively correlated with activity (it is), but whether it explains the variation in activity more so than several credit factors. The chart below compares how much (in percent) of the variation is explained by our risk premium versus three credit market factors that others have argued characterize the level of credit risk (the spread on a high-yield bond index, a measure of credit risk constructed by Gilchrist and Zakrajsek [2012], and the spread of firm cash flows relative to high-yield rates). Whether we consider the volume or value of buyout activity, we find the risk premium explains two to three times more of the time series variation.

<img class=”asset asset-image at-xid-6a01348793456c970c01b8d1102c76970c img-responsive” explained=”” variance=”” in=”” deal=”” activity – risk=”” premium=”” versus=”” credit=”” factors”=”” title=”Explained Variance in Deal Activity – Risk Premium versus Credit Factors” data-cke-saved-src=”http://libertystreeteconomics.typepad.com/.a/6a01348793456c970c01b8d1102c76970c-450wi” src=”http://libertystreeteconomics.typepad.com/.a/6a01348793456c970c01b8d1102c76970c-450wi” style=”border: 0px; margin: 0px; padding: 0px; font-size: 0px; color: transparent; vertical-align: middle; font-family: Georgia, ‘Times New Roman’, Times, serif; line-height: 18px; width: 450px;”>

Another implication of the investment framework is that deals for highbeta firms will be more sensitive to changes in the risk premium. This finding follows directly from a classic cost-of-capital calculation where the cost of capital equals the risk-free rate, Rf, plus the firm’s beta times the risk premium on market assets relative to the risk-free rate, RM -Rf:

Equation 2

Recall the cost of capital is used as the discount rate for investments. When the risk premium increases, the discount rate for high beta firms increases more quickly than for low beta firms. By extension, the present value of the buyout declines more for high beta firms than low beta firms. Therefore, high beta firms should be less attractive buyouts when the risk premium is low. In fact, the chart below demonstrates that buyouts of higher beta firms are less common when the risk premium is high compared with when it is low.

Distribution of Buyout Deal Betas when the Risk Premium is High and Low

Final Thoughts

The dialogue around buyouts has traditionally centered on the role of credit markets. However, in the big picture, the aggregate risk premium – the overall demand for risk by all types of investors – is the primary determinant of buyout activity. Given that many investment decisions are a function of the risk premium, we expect initial public offerings, mergers and acquisitions, and other types of corporate financial activity to also be closely related to time variation in the risk premium.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source

http://libertystreeteconomics.newyorkfed.org/2015/06/what-drives-buyout-booms-and-bust.html#.VWxAtc9ViWU


About the Authors

Valentin Haddad is an assistant professor of economics at Princeton University.

Erik Loualiche is an assistant professor of finance at the MIT Sloan School of Management.

Plosser MatthewMatthew Plosser is an economist in the Federal Reserve Bank of New York’s Research and Statistics Group.

Previous Post

Early Headlines: Red State HIV Epidemic, NSA Spying Expires, No Stimulus in China, China Manufacturing Stabilizing, Germany Has World’s Lowest Birthrate and More

Next Post

May 2015 ISM Manufacturing Survey Marginally Improved and Remains in Expansion

Related Posts

India’s Largest Retailer Tests Digital Rupee
Economics

India’s Largest Retailer Tests Digital Rupee

by John Wanguba
February 5, 2023
Apple Forecasts Another Plunge In Revenue, Says iPhone Production Issues Over
Business

Apple Forecasts Another Plunge In Revenue, Says iPhone Production Issues Over

by John Wanguba
February 5, 2023
U.S. Weekly Jobless Claims Dropped To 9-Month Low; Productivity Gains Accelerate
Economics

U.S. Weekly Jobless Claims Dropped To 9-Month Low; Productivity Gains Accelerate

by John Wanguba
February 5, 2023
Bitcoin Flirts With $24K, How High Will It Go?
Economics

Bitcoin Flirts With $24K, How High Will It Go?

by John Wanguba
February 3, 2023
Venezuela's PDVSA Toughens Oil Prepayment Terms
Business

Venezuela’s PDVSA Toughens Oil Prepayment Terms

by John Wanguba
February 2, 2023
Next Post

May 2015 ISM Manufacturing Survey Marginally Improved and Remains in Expansion

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Browse by Category

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Browse by Tags

adoption altcoins banking banks Binance Bitcoin Bitcoin adoption Bitcoin market Bitcoin mining blockchain BTC business China crypto crypto adoption cryptocurrency crypto exchange crypto market crypto regulation decentralized finance DeFi Elon Musk ETH Ethereum Europe finance FTX inflation investment market analysis markets Metaverse mining NFT nonfungible tokens oil market price analysis recession regulation Russia technology Tesla the UK the US Twitter

Archives

  • February 2023
  • January 2023
  • December 2022
  • November 2022
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • June 2022
  • May 2022
  • April 2022
  • March 2022
  • February 2022
  • January 2022
  • December 2021
  • November 2021
  • October 2021
  • September 2021
  • August 2021
  • July 2021
  • June 2021
  • May 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • August 2010
  • August 2009

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized
Global Economic Intersection

After nearly 11 years of 24/7/365 operation, Global Economic Intersection co-founders Steven Hansen and John Lounsbury are retiring. The new owner, a global media company in London, is in the process of completing the set-up of Global Economic Intersection files in their system and publishing platform. The official website ownership transfer took place on 24 August.

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Recent Posts

  • India’s Largest Retailer Tests Digital Rupee
  • Apple Forecasts Another Plunge In Revenue, Says iPhone Production Issues Over
  • U.S. Weekly Jobless Claims Dropped To 9-Month Low; Productivity Gains Accelerate

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

No Result
View All Result
  • Home
  • Contact Us
  • Bitcoin Robot
    • Bitcoin Profit
    • Bitcoin Code
    • Quantum AI
    • eKrona Cryptocurrency
    • Bitcoin Up
    • Bitcoin Prime
    • Yuan Pay Group
    • Immediate Profit
    • BitIQ
    • Bitcoin Loophole
    • Crypto Boom
    • Bitcoin Era
    • Bitcoin Treasure
    • Bitcoin Lucro
    • Bitcoin System
    • Oil Profit
    • The News Spy
    • British Bitcoin Profit
    • Bitcoin Trader
  • Bitcoin Reddit

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

en English
ar Arabicbg Bulgarianda Danishnl Dutchen Englishfi Finnishfr Frenchde Germanel Greekit Italianja Japaneselv Latvianno Norwegianpl Polishpt Portuguesero Romanianes Spanishsv Swedish