Disciplining Management or Guiding Management: Aligning Interests in Securitized Leveraged Buyouts

Date01 January 2015
Published date01 January 2015
DOIhttp://doi.org/10.1002/jcaf.22013
3
© 2015 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22013
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Laurent Bouvier
and Tahir M. Nisar
Leveraged buyouts (LBOs) are generally explained
in terms of a governance mechanism that dis-
ciplines management. It is operationalized by
increasing the leverage of a firm, which has an
implicit consequence of constraining management
in the use of free cash flows. However, under a
relatively new form of LBO known as securitized
leveraged buyouts, private equity firms raise funds
on the back of the acquired company’s operat-
ing assets. A securitized LBO imposes explicit
restrictions on management with regard to its
freedom for carrying out strategy decisions. Using
the case study of Hertz, we show how a secu-
ritized LBO can be structured more efficiently
and what important decisions must be made
in order to improve its debt service capacity.
© 2015 Wiley Periodicals, Inc.
D isciplining Management or Guiding
Management: Aligning Interests in
Securitized Leveraged Buyouts
Leveraged buy-
outs (LBOs) are
generally associ-
ated with the use of
efficient funding tools
in securing LBO deals.
With the emergence
of structured credit
markets in the 1990s
and early 2000s, oppor-
tunities also arose for
private equity sponsors
to employ structured
credit products in the
acquisition of target
companies and hence
reduce the cost of
credit.
For example,
Carlyle Group, Bain
Capital, and Thomas
H. Lee Partners coalesced to
buy the coffee and doughnut
chain, Dunkin Brands Inc., in
March 2006. The consortium
subsequently securitized most
of Dunkin Brands’ intellectual
property and other intangible
assets. At around the same time,
other major deals occurred that
had similar financing structures
to that of the Dunkin Brands’
deal. For example, Hertz issued
asset-backed securities worth
$4.3 billion in December 2005,
while Domino’s Pizza issued
securities worth $1.85 billion in
April 2007.
In this article, we examine
how a securitized LBO can be
structured as a new form of pri-
vate equity acquisition strategy.
We also investigate the degree
to which a securitized LBO
affects the management and
organization of the
acquired assets, as
well as their perfor-
mance.
As a securitized
LBO is about sup-
porting the business
operator in terms
of specifying a plan
that links various
management strate-
gies and actions to
achieving a mini-
mum level of perfor-
mance, it is different
from a traditional
LBO in many impor-
tant respects. For
instance, high lever-
age in a traditional
LBO is thought to
discipline company management
through constraining opportu-
nistic management behaviors
with regard to the wasteful use
of free cash flows (Jensen, 1986 ).
A securitized LBO, however, is
characterized by a contractual
requirement for the company
to adhere to a prespecified plan
incorporating restrictive condi-
tions on asset restructuring (e.g.,
acquisitions or disposals), the

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