Private Equity and the Resolution of Financial Distress

In order to understand the role of private equity firms in the restructuring of financially distressed firms, we examine the private equity ownership of 2,156 firms which obtained leveraged loan financing between 1997 and 2010. The economic downturn beginning in 2007 is associated with a marked increase in defaults of these highly leveraged companies; approximately 50% of defaults involve PE-backed companies. However, PE-based firms are no more likely to default during this period than other firms with similar leverage characteristics. But defaulting firms that are private equity backed spend less time in financial distress and are more likely to survive as an independent reorganized company versus being sold to a strategic buyer or liquidated. The ability to restructure more efficiently seems to be affected by the PE – sponsor’s financial as well as reputational capital. In contrast, recovery rates to junior creditors are lower for PE – backed firms.