Regulation of Leveraged Buyouts: Law & Economics Anaysis and Policy

  • Yu, Chi-Chang (PI)

Project: National Science and Technology CouncilNational Science and Technology Council Academic Grants

Project Details


Leveraged buyouts (LBOs) are the most fascinating and controversial merger and acquisition transactions. In an LBO, the acquirer can buy a company’s shares by using large amounts of debt to finance the acquisition. The debt will be repaid by using cash flows generated from the target company’s operation or by selling the company’s so-called “non-core” assets. If the debt is fully repaid eventually, the acquirer will take over the target company, which has been acquired with money of the target firm, not the acquirer. The modern LBO transaction usually proceeds in two stages. First, the acquirer creates a shell corporation to obtain debt from a bank, or issues high-yield bonds (the so-called “junk bonds”) to finance the acquisition of the target company. Once the shell corporation owns a significant portion of the target company’s shares, the acquirer can merge the target company with the shell company. As a result, debt will be automatically transferred from the shell company to the target firm. Since LBOs increase the debt ratio of the target company, the debt serving obligations associated with high leverage can provide valuable governance by acting as a discipline on management. High debt levels also mean benefits of tax deductibility of interest charged. One subset of LOBs is management buyout, in which the management, usually accompanied by a private equity fund, purchases the target’s shares and drives the minority shareholders out of the company through a cash-out merger (also known as freezeouts). Consequently, the combination of management and ownership largely reduces agency costs. However, high leverage increases the risk incurred by “old” creditors. The “new” creditors end up sharing the company’s assets with the “old” creditors in the event of bankruptcy; this occurrence reduces the expected recoveries of the “old” creditors if the company defaults. Also, the privatization or freezeout transactions associated with management buyouts can harm the minority shareholders resulted from information asymmetry. The management may take the advantage of equipping information that the minority shareholders cannot access. In recent years, as LBO activities have risen to unprecedented levels in U.S. and European markets, they also became more active in Taiwan. Private equity (PE) funds have conducted acquisitions of several local banks through syndicated loans. However, in 2008’s financial tsunami, the market prices of these shares, which acted as collateral, fell far below the estimated value due to the high debt-to-equity ratio of the acquired banks. In addition, a management buyout of a computer ancillary equipment manufacture represented another unusual case. The management squeezed out of minority shareholders through a two-tier merger transaction, assisted by a PE fund and investment banks in 2007, and became private. Nevertheless, less than three years later, the company announced that they would seek to go public again. Therefore, legal control is needed to screen out the inefficient buyouts from efficient ones. The regulation of LBOs can be found in two completely different approaches: an ex post remedy and an ex ante approval. The demerit of the former is the high cost of adjudication; however, the danger of the latter is the risk of over-killing. The most appropriate regulation approach depends on the conditions of local capital market and judicial systems.

Project IDs

Project ID:PF10007-1693
External Project ID:NSC100-2410-H182-006
Effective start/end date01/08/1131/07/12


  • leveraged buyout
  • management buyout
  • management buy-in
  • private equity firm
  • private equity fund


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