The History of Kohlberg Kravis Roberts - KKR

Kohlberg Kravis Roberts (KKR) creative approach to large scale buyouts transformed the American financial market. By pursuing large-scale leveraged buyouts (LBO), investment banks and other investors followed KKR in focusing on M&A between 1980 and 1990. I will summarise how KKR’s business model, explain the financial obstacles it overcame and argue that this model was effective to financing innovation in theory but failed in practise.

1)Who were KKR

KKR’s specialised in buying and selling control of companies they thought they could reorganise to make more valuable. By identifying underperforming or undercapitalised firms, they could then purchase it through a LBO and restructure it. By supplying specialised managers to the firm, KKR was able to transform firms into profitable and valuable companies. After KKR’s first success stories, commercial banks and pension funds were eager to provide capital for further investment – Washington’s pension fund entrusted $100m (10% of KKR’s total fund) in 1984 to KKR for investment. KKR’s success promoted LBOs by other investment banks and hedge funds culminating in an era of megadeals between 1985 and 1989 and a peak in the number of hostile takeovers.

KKR founders George Roberts and Henry Kravis

2) Why were KKR successful?

KKR’s success was due to its innovative approach to dealing with management. Previously, takeovers were difficult due to investor’s collective action and monitoring problem. Kaufman explains that LBO;s reduced collective action problems and agency costs by aligning managerial and property interests through common ownership. By granting managers substantial equity holdings in the firm, monitoring costs were reduced, whilst they had an individual motivation to make the firm as successful as possible. Additionally, by KKR aligning its interests with those of institutional investors, the cost of collective action was also reduced. This made financing much easier. Profits were readily available to KKR through its fee structure, and placing the debt on the company, so financial risk was minimised.

KKR Portfolio

3) Why did they fail?

Nevertheless, this model failed to be conducive to financing innovation. KKR was successful and the companies it bought were able to reorganise and innovate in order to stay competitive. Kaufman described KKR as an ‘industrial entrepreneur’ by 1992. However, the model failed since it led to bidding wars between investment banks which moved to taking up reckless equity positions in order to make quick profits. This concluded in a junk-bond market crash of 1990. The use of LBO to buy a firm, although helpful, only worked when done by specialists with the correct motivations – to finance innovation for a firm to become more competitive. Not to make a quick profit.

Downward decline

Overall, KKR was successful since it was able to minimise the traditional agency costs that have troubled managerially controlled firms. It delivered financing for firms to innovate. However, LBO’s caused a market crash and did not succeed in financing innovation for the wider financial community.