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The institutional environment regulating mergers and acquisitions (M&A) is crucial for the private equity industry, especially for leveraged buyout (LBO) transactions, which are currently at the center of an intensive debate in the US, as seen in many European countries over the last decade. One of the most controversial issues of an LBO deal is associated with its ultimate economic result, often perceived as an indirect and fraudulent example of financial assistance provided by the acquired firm for the purchase of its own shares, to the detriment of its assets and stakeholders. Given the potential damage to the target’s stakeholders, LBOs have been strongly debated and even prohibited in Italy. The institutional uncertainty surrounding the legitimacy of LBOs had a negative impact on the Italian private equity market. Recently, Italy issued an innovative corporate governance reform which offered a more favorable legal environment to this type of transactions and represented an important turning point for the domestic private equity market. The institutional change, induced by the above reform, provides scholars and policy makers with guidelines on how PE transactions may be spurred with an appropriate regulation aimed at legalizing LBOs, as well as protecting the interests of the target firm and its stakeholders. Notwithstanding the new reform, several issues remain unsolved and the admissibility of certain types of LBOs is still under debate. The purpose of this paper is two-fold: a) to shed some light on the debate on the legitimacy of LBOs by emphasizing, from an economic and financial point of view, the critical features of this class of transactions, and b) to highlight unsolved problems associated with the new LBO reform, particularly with reference to the investors’ liability. The Italian buyout market, whose transactions were previously prohibited and only recently legalized, offers a unique example in order to better understand the current international debate on the admissibility of LBOs and the related consequences for the target’s stakeholders.

The dark side of LBOS. Private equity investors be forewarned!