The 1980s marked a significant period of change in corporate finance, largely driven by a surge in leveraged buyouts (LBOs). The total value of these transactions grew from $1.2 billion in 1979 to $44.3 billion in 1986. This era was characterized by a substantial increase in corporate leverage, with debt levels in LBOs often exceeding 80% of total capital. Research indicates that during this time, buyout price-to-cash flow ratios increased, and the use of public junk bonds replaced private subordinated and bank debt. This shift led to an acceleration in required bank principal repayments, resulting in sharply lower ratios of cash flow to total debt obligations. These patterns were seen by some analysts as signs of an "overheating" phenomenon in the buyout market [ideas.repec.org].
One of the defining characteristics of LBOs was the substitution of debt for equity. For example, a sample of 58 LBOs between 1980 and 1984 showed the average debt-to-equity ratio rising from 0.457 to 5.524, an increase of over 1100%. Premiums paid for target firms were substantial, averaging about 36.3% and median premiums around 30.6% from 1979 to 1988 across various market values [doi.org]. The increase in leverage was so significant that from 1984 to 1990, over $500 billion of equity was retired as corporations repurchased shares, borrowed for takeovers, and went private through LBOs [doi.org].
These transactions created a new organizational form, often involving a shift from publicly traded stock to equity held by a smaller number of individuals, particularly in "going-private" transactions [doi.org]. Venture capitalists played a larger role, often becoming the largest shareholders and controlling the board of directors, thereby increasing monitoring of management compared to typical public corporations [bostonfed.org]. However, the increased leverage and aggressive financing methods, particularly the rise of junk bonds, raised concerns. While many LBOs generated improvements in operating profits, approximately one-third of LBOs completed after 1985 subsequently defaulted on their debt, highlighting the inherent risks in this financing approach [doi.org]. The case of Federated Department Stores, acquired by Campeau in 1988, is often cited as a notable example, where despite generating $5.85 billion in value after the purchase, Campeau had paid $7.67 billion, ultimately leading to bankruptcy [doi.org].
