When private equity firms acquire companies through leveraged buyouts, both the quality and the quantity of innovation at the businesses suffer, new research shows.
Public-to-private buyouts, particularly those done by private equity firms, saddle companies with so much debt that they can no longer innovate at the same rate they once did, according to a paper last month by Florida Atlantic University economics professor Douglas Cumming, University of Exeter Business School lecturer Monika Tarsalewska, and DeepR Analytics chief executive officer Rejo Peter.
The finding refutes earlier research that showed that buyouts had a positive correlation to innovation at target companies, according to the authors of the new paper.
“We had a much wider number of buyout deals,” Peter said by phone. “We felt it was time to look at it in a more international and contemporary context. Once we started, we started asking ourselves more important questions.”
Peter, Cumming, and Tarsalewska analyzed 1,545 buyouts completed globally from 1997 to 2011, a sample involving 48,368 patents.
The authors said the number of patent citations fell between 33 percent and 38 percent in the third year following a buyout by a private equity firm because of the high amount of leverage used to finance the deals, according to the paper.
“It is mostly driven by the relative cost of debt,” the authors wrote. “In particular, we find that, if the acquirer cannot lock in the financing for the buyout transaction at a lower rate than the other market participants’ cost of debt, then this may negatively impact investment and therefore innovation.”
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The trend becomes worse after 2006, according to the paper.
“You’ve locked in at a higher interest rate,” Peter said. “We find that that relative difference or ratio has a significant negative impact on both quality and quantity of innovation.”