Andre Betzer looks at European Leveraged Buyouts (financed with at least 50% debt) to determine if Jensen's Free Cash Flow (FCF) Hypothesis can explain (or predict) the the LBO.
Jensen's FCF hypothesis is that firms with high levels of Cash flow will waste it on negative NPV projects. From this, it has been theorized that Leveraged Buyouts solve the problem by not only removing management (at least in some cases) but also the debt associated with the LBO reduces management's discretion when it comes to the cash (thus they can not waste the cash flow).
Betzer's findings? Largely (but not completely) along lines of Jensen's hypothesis.
Specifically Betzer finds that firms with low P/Es and high cash flow are more likely targets:
"univariate and multivariate findings indicate that European companies with high Cash Flows before distribution and few investment opportunities whose P/E ratio is significantly lower than that of their industry peer group are more likely to be an LBO target."Which is consistent with what the FCF hypothesis. However, he does not find evidence of agency costs (although I might submit that agency costs may be the reason for the lower P/E ratio and are just not being captured in the proxies):
"all variables proxying for agency problems (namely FCF (AD), CAPEX and Free Float) in the multivariate analysis are insignificant."Definitely not the last word, but interesting!
Betzer, André, "Does Jensen’s Free Cash Flow Hypothesis Explain European LBOs Today?" (March 2006). Available at SSRN: http://ssrn.com/abstract=875363