Buyout Activity: The Impact of Aggregate Discount Rates - Federal Reserve Bank of New York

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Buyout Activity: The Impact of Aggregate Discount Rates

March 2013 Number 606
Revised: August 2015

JEL classification: G11, G23, G34

Authors: Valentin Haddad, Erik Loualiche, and Matthew Plosser

Buyout booms form in response to declines in the aggregate risk premium. We document that the equity risk premium is the primary determinant of buyout activity rather than credit-specific conditions. We articulate a simple explanation for this phenomenon: a low risk premium increases the present value of performance gains and decreases the cost of holding an illiquid investment. A panel of U.S. buyouts confirms this view. The risk premium shapes changes in buyout characteristics over the cycle, including their riskiness, leverage, and performance. Our results underscore the importance of the risk premium in corporate finance decisions.

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