Monetary policy and private equity acquisitions: tracing the links
Summary
Focus
We examine how monetary policy affects private equity acquisitions. Specifically, we analyse the effects of monetary policy on the volume of deals, the use of leverage and the pricing of transactions, highlighting the transmission channels of monetary policy in the private equity sector.
Contribution
We investigate the role of two key transmission channels: (i) a credit channel through which monetary policy affects the cost and availability of credit to complete private equity transactions; and (ii) a valuation channel through which monetary policy influences the discount rates and the expected present value of future capital gains, affecting private equity managers' incentives to go ahead with these acquisitions. We further compare the effects of monetary policy shocks on short-term interest rates (eg two-year yields) with those on long-term interest rates (eg 10-year yields), providing insights into the different impact of conventional and unconventional monetary policy.
Findings
We find that monetary policy shocks that affect the short end of the yield curve tend to dampen private equity activity, by reducing both the volumes and prices of deals as well as the use of leverage. The credit channel of monetary transmission seems to affect deal volumes and the use of leverage, while the valuation channel appears to dominate the transmission to deal pricing. Monetary policy shocks that affect the long end of the yield curve have weaker effects on private equity activity.
Abstract
Private equity funds play an increasingly important role in financial systems. Yet, the impact of monetary policy on their activity has been little explored so far. In this paper, we analyse the transmission of monetary policy through private equity (PE) deals, focusing on the impact on: (i) the volume of private equity deals; (ii) the use of leverage; and (iii) the pricing of those deals. We find that contractionary monetary policy shocks to the short end of the yield curve tend to dampen private equity activity, by reducing deal volumes, the use of leverage and deal prices. A credit channel of monetary transmission seems to affect deal volumes and the use of leverage, while a valuation channel appears to drive the transmission to deal pricing. Monetary policy shocks to the long end of the yield curve have weaker effects on PE activity.
JEL Classification: G21, G32, F32, F34
Keywords: private equity, buyouts, monetary policy, credit spreads, equity risk premium
