Theories of Leveraged Buyouts and Theories of Market Instability

Abstract

In Chapter 5, I focused on the internal dynamics of why private equity finance expands to exploit available liquidity. In so doing I made the point that it can be seen as a claimed solution that creates new problems. Those problems included complex debt structures and rising leverage. In this chapter, I look at the theorisation of PEF LBOs. I do so with a focus on Michael Jensen’s work because he has been the outstanding scholar in this field. His work is the foundation of all other theories of LBOs. Others tend to absorb his key insights and appropriate his key concepts.¹ Jensen’s approach begins from the way the possibility of an LBO is signalled creating a market for corporate control. The initial basis for this signalling became his free cash flow theory. His work, however, is important beyond free cash flow as a market signal. For Jensen, debt is not just a necessary adjunct of an LBO. It is also a positive disciplining force that helps make PEF a desirable model of business organisation. I argue, however, that one can deconstruct Jensen’s approach to show that it is less coherent than it initially appears. Moreover, Jensen’s approach also involves a series of normative commitments that rely on a basic understanding that PEF responds to historical dynamics but is not itself shaped by them. I argue that if one thinks of PEF as a constitutive part of the growth of unstable liquidity then PEF is also historically dynamic. In so far as this is the case, debt ceases to be an unambiguous source of discipline.