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Why Are Buyouts Levered? The Financial Structure of Private Equity Funds





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    • Ulf Axelson is with the Stockholm School of Economics and SIFR. Per Strömberg is with the Stockholm School of Economics, SIFR, CEPR, and NBER. Michael S. Weisbach is with Ohio State University and NBER. We would like to thank an anonymous referee, Diego Garcia, Campbell Harvey (the editor), Bengt Holmström, Antoinette Schoar, and Jeremy Stein (the associate editor) for helpful comments, and seminar participants at University of Amsterdam, UC Berkeley, Boston College, CEPR Summer Institute 2005, University of Chicago, ECB-CFS, Emory University, Harvard University, Helsinki School of Economics, HKUST, University of Illinois at Urbana-Champaign, INSEAD, MIT, NBER 2005, Norwegian School of Economics, NYU, Oxford University, Paris-Dauphine University, Rutgers University, SSE Riga, Stockholm School of Economics, University of Texas, Vanderbilt University, Stockholm University, University of Virginia, Washington University, and WFA Meetings 2005.


Private equity funds are important to the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to aggregate credit conditions and investments in bad states outperform investments in good states.