Leveraged Buyouts

This research examines leveraged buyouts (LBOs). Specifically, it attempts to determine whether or not LBOs are either good or bad for the American economy.

LEVERAGED BUYOUTS AND JUNK BONDS

LBOs and their effect on the American economy cannot be adequately discussed without also considering junk bonds. The reason for this necessary linkage is that junk bonds are used to finance LBO deals.

A leveraged buyout is one in which the cost of the purchase is largely borne by the firm being acquired. In most instances, these deals are structured to be financed by socalled junk bonds.

Junk bond is the term used to describe an (1) original issue, (2) highyield, (3) lowgrade, (4) corporate bond (Weinstein, 1987, p. 76). In the context of high and lowgrade, this definition is generally applied so that the lowest ranked bond which would be included in the highgrade classification would be Moody's Baa (Weinstein, 1987, p. 76).

Junk bonds, thus, are, generally speaking, those original issue corporate bonds which are below investmentgrade. Investmentgrade bonds are typically considered to be bonds included in the highgrade classification.

Lowgrade bonds are generally associated with higher risk levels than those which characterized highgrade, or investmentgrade, bonds. Thus, while junk bonds offer a higher potential return on investment, the risk that the investment will be l

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ON THE AMERICAN ECONOMY LBOs tend to create conflicts between corporate managements and existing shareholders. If management cooperates with the group engineering the LBO, the existing shareholders may view that action as detrimental to their own interests. On the other hand, if management either attempts to negotiate a high exchange price for the firm's common shares, shareholder discontent with management may be minimized. In some situations, existing shareholders may desire that management resist the attempted takeover. Should management not make such an attempt, shareholders may be led to think that management is attempting to make the best possible deal for itself, while ignoring the interests of the existing shareholders. In addition to creating conflicts between managements and existing shareholders, LBOs may also create conflicts in decision alternatives related to investment, financing, and dividends. In a firm which has been acquired through an LBO, management is required to deal with a significantly higher debt than that which existed prior to the leveraged buyout. Management must, thus, devote its attention to maintaining the liquidity of the firm under more difficult condit
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Approximate Word count = 1830
Approximate Pages = 7 (250 words per page)

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