Research Brief: For International LBOs, Join the Club

What Did the Study Look At?

In recent years, cross-border leveraged buyouts (LBOs) have fueled the flow of foreign direct investment. Typically, LBOs are led by savvy private equity investors such as hedge funds that use large amounts of leverage to acquire target firms; their intent is to quickly build value and cash out via a sale or initial public offering.

Investors face special challenges when trying to orchestrate an LBO across borders. Differences in formal and informal institutions — regulatory environment, economic bodies, political make up, and culture, for example — can all influence foreign direct investment decisions. Successful LBOs require access to debt financing and options for exit strategies, so they tend to be particularly affected by target countries’ approach to such matters as shareholder protection and creditor rights.

These researchers study the importance of country-level institutions in hindering or promoting the completion of these deals. At the macro level, they examine the influence of formal institutions on the choice of target country for an LBO deal, and how differences influence the number and dollar volume of LBO deals occurring between two countries. At the deal level, they look at whether country differences influence the probability of a deal being successfully concluded and the length of time required in negotiations. 

They also examine whether club deals — LBOs that involve multiple private equity firms — can help overcome institutional differences between target and buyer countries. 

How Was the Study Designed?

The study is based on a sample of cross-border LBO transactions obtained from Standard and Poor’s Capital IQ database. Each LBO transaction was announced between 1986 and 2013 and valued at $10 million or larger, yielding 3,154 LBO transactions.

Dominating the sample are U.S. firms, both in terms of private equity acquirers and target firms. European countries host 65 percent of the LBO targets and 53 percent of the private equity investors. In terms of country-pairs, the U.S.-UK, U.S.-Canada, UK-France, and UK-Germany combinations are the most common private equity-target combinations. 

What Did the Study Find?

• The institutional environment of the target firm country and differences in formal and informal institutions between LBO buyer and target countries affect the volume of cross-border LBOs at the country level and, at deal level, the likelihood of both deal completion and the time required for negotiation.
• Countries with a British common law system and high level of restrictions on foreign direct investment host far fewer cross-border LBOs.
• At the deal level, political relations and cultural distance between the nations of the negotiating parties can have a significant impact on a deal’s successful completion. Negotiations take longer when there are large cultural differences between the parties, and when the target country features strong foreign direct investment restrictions and shareholder protection laws. 
• Club deals involving diverse private equity investors can significantly reduce institutional barriers. They increased the probability of deal completion and shortened negotiation times, largely by reducing the cultural differences between the buyer and target countries. There was no evidence of these benefits when clubs were composed of members from similar institutional environments. 

What Do I Need to Know?

Culture can trip up a cross-border LBO deal in many ways, the researchers say. “Negotiators from individualistic cultures, for instance, may have the power to accept or reject offers on the spot whereas negotiators from other cultures may have to make decisions collectively through voting or report to someone of higher hierarchy,” they point out in their working paper. Similarly, ethnic and gender stereotypes may affect how comfortable negotiators are with their counterparts.

What is a barrier is also an opportunity. The researchers advise investors to look for partners who share characteristics with the target country rather than restricting their interest to partners in the host country alone. “Having investors from different institutional backgrounds enhances the diversity of perspectives at the bargaining table and may serve to reduce barriers that otherwise would exist between a single buyer and target from vastly different backgrounds,” they point out. Club deals need not include members of the target country, which is good news for those assembling an LBO in emerging markets where few local partners may exist.

Title: “Can Club Deals Reduce Institutional Barriers to Cross-Border LBOs?”

Authors: Chen Liu (Trinity Western University), Lynnette Purda (Smith School of Business), Hui Zhu (University of Ontario Institute of Technology)

— Alan Morantz