The Determinants of Leveraged Buyout Activity: Free Cash Flow vs. Financial Distress Costs




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    • Cox School of Business, Southern Methodist University and Hong Kong University of Science and Technology, respectively. We thank seminar participants at UCLA, the 1992 AFA meetings, an anonymous referee, Jim Brandon, Larry Lang, Scott Lee, Julia Liebeskind, Jeffry Netter, Krishna Palepu, Gordon Phillips, Annette Poulsen, David Ravenscraft, Richard Ruback, Mike Vetsuypens, and Ivo Welch for helpful discussions and comments.


This paper investigates the determinants of leveraged buyout (LBO) activity by comparing firms that have implemented LBOs to those that have not. Consistent with the free cash flow theory, we find that firms that initiate LBOs can be characterized as having a combination of unfavorable investment opportunities (low Tobin's q) and relatively high cash flow. LBO firms also tend to be more diversified than firms which do not undertake LBOs. In addition, firms with high expected costs of financial distress (e.g., those with high research and development expenditures) are less likely to do LBOs.