214 JulyYSeptember & 2012

The performance of the leveraged

buyout of the Hospital Corporation
of America, Inc.
Tae Hyun Kim
Michael J. McCue

Background: A leveraged buyout (LBO) is a type of corporate reorganization and acquisition practice whereby
private investors borrow a substantial amount of debt to acquire a firm by buying back its publicly held stock to go
private. The Hospital Corporation of America, Inc. (HCA), went through its second LBO in July of 2006. A prior study
on the performance changes of the first LBO found no significant changes in revenues, expenses, or profitability.
Purposes: In this study, we evaluated the changes in performance measures for HCA hospitals during the
second LBO period. We looked at the effect of the LBO on financial and operational performance indicators,
controlling for market and hospital characteristics.
Methodology: We identified 121 urban HCA hospitals that consistently reported data over a 4-year window from
1 year pre-LBO to 3 years post-LBO and evaluated their study performance changes during the period. Primary data
for operational and financial measures are derived from Health Care Cost Report Information System data sets.
Findings: On the basis of this study, the LBO led to significant increases in cash flow margin, net patient revenues,
and total asset turnover ratio. It also increased operating expenses significantly. However, it was not associated
with changes in labor costs, staffing, and capital investment.
Practice Implications: The management of publicly traded hospitals that consider an LBO should develop operating
strategies to maintain a strong cash flow performance and find ways to boost patient volume. It also needs to determine
if it would be able to continue investing in its facilities to keep physicians and patients loyal and to keep investing in the
training and retention of employees, which ultimately improves the quality of care and enhances operational efficiency.

I
n July of 2006, the senior management of the Hospi-
tal Corporation of America, Inc. (HCA), coupled with
three private equity firms, went through a $33 billion
leveraged buyout (LBO) by issuing debt to buy back its
stock and, in turn, was able to operate as a private company
Key words: cash flow, hospital, leveraged buyout, revenue,
staffing
Tae Hyun Kim, PhD, is Assistant Professor, Department of Hospital
Administration, Graduate School of Public Health and Institute of Health Ser-
vices Research, Yonsei University, Seoul, South Korea. E-mail: thkim@yuhs.ac.
Michael J. McCue, DBA, is Professor, Department of Health Admin-
istration, Virginia Commonwealth University, Richmond, Virginia.
The authors have disclosed that they have no significant relationship with,
or financial interest in, any commercial companies pertaining to this article.
DOI: 10.1097/HMR.0b013e318235ed42
Health Care Manage Rev, 2012, 37(3), 214Y222
Copyright B 2012 Wolters Kluwer Health | Lippincott Williams & Wilkins
(Corporate Financing Week, 2006). In May of 2010, HCA
and its private equity investors decided to go public again
with plans for an initial public offering of stock for $4 bil-
lion (Galloro, 2010).
This recent LBO was HCA’s second LBO. In March of
1989, HCA underwent an LBO of 53 acute care hospitals
and 53 psychiatric hospitals. Three years later, HCA re-
capitalized itself by going public with its stock. A prior
study conducted on the performance changes of the first
HCA’s LBO found no significant changes in revenues, ex-
pense, or profitability (Clement & McCue, 1996).
From a practice perspective, hospitals with such an
unprecedented layer of debt face tremendous operating
pressure to lower costs, especially labor, and increase their
patient revenues to generate sufficient cash flow to pay
down their debt. Therefore, a study of this nature will pro-
vide hospital managers and policy makers a greater un-
derstanding on how HCA hospitals and their managers
reacted to this overburden of debt. Prior corporate finance

Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
Leveraged Buyout of HCA, Inc.
studies found that companies operating under an LBO
were found to lower labor costs (Long & Ravenscraft, 1993),
raise prices (Chevalier, 1995), and decrease capital expen-
ditures (Kaplan, 1989).
As noted above, few studies have analyzed this sig-
nificant change in capital structure within the hospital
industry. Therefore, the aim of this study was to conduct
a multivariate analysis of these changes in cash flow, op-
erations, efficiency, capital investment, and staffing for
HCA hospitals during the LBO period.
Trends in LBOs
The initial boom of LBOs occurred in the late 1980s and
the early 1990s. The highest number of deals occurred in
1988, with 430 transactions at a total value of $180 billion
(Eckbo & Thorburn, 2008). The recession of 1990Y1991,
coupled with the lack of access to junk bonds, resulted in
the decline in number of these LBO transactions. Before
the credit crisis of 2008, cheaper debt financing in the
mid-2000s spurred a second buyout boom with the high-
est number of deals occurring in 2007, with over 790 trans-
actions totaling over $450 billion in value (Eckbo &
Thorburn, 2008). LBOs in the 2000s differ from LBO
transactions in the 1980s in several areas (Government
Accountability Office [GAO], 2008). First, LBOs in the
1980s were more likely to be hostile transactions, whereby
the management of target companies did not want to be
purchased. Second, LBOs in the 1980s occurred in specific
industries such as manufacturing and retail. In the 2000s,
however, LBOs have expanded to other industries such
as technology, financial services, and health care.
Third, in the earlier period of LBOs, high-debt positions
reduced agency costs by forcing managers to act more like
owners in maximizing firm profits by reducing costs and
selling assets (Jensen, 1989). In addition, investors in LBOs
wanted to improve firm value by the benefits of debt, spe-
cifically through tax savings of interest and the ability of
debt to generate higher earnings through leverage. In the
recent period of 2000s, LBO transactions were focused
not only on cost reduction and financial benefit of debt
but also on improved operations and revenue growth of
the LBO companies. Finally, in the 2000s, LBO transac-
tions were acquired by pooling the funds of several private
equity firms to acquire these firms. The higher purchase
price to buy a larger company was the driving factor for
combining these resources. In the case of HCA, three pri-
vate equity companies, Bain Capital Partners, Kohlberg
Kravis Roberts & Co., and Merrill Lynch Private Equity,
were partners in this purchase.
Theory/Conceptual Framework
There exists an array of underlying motives why compa-
nies undergo an LBO. These motives range from man-
Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
215
agement possessing inside information about the future
prospects of the company, increasing firm value from in-
terest tax savings of debt, and improving the operating per-
formance of the company (Opler & Titman, 1991). These
prior motives are measured at the company level; however,
LBO studies also focused on the effects of the LBO at the
plant level (Kaplan, 1989; Chevalier, 1995). Through this
study, a follow-up on the latter was done by collecting op-
erating and financial performance data from the individ-
ual hospitals of HCA.
The theoretical basis of this study is Jensen’s (1986)
view of agency theory. The underpinning of this theory is
the excess cash remaining after the company has invested
in all profitable investment opportunities. He claims that
how companies use their free or excess cash flow creates a
conflict between management and their owners. Because
a company has invested its cash in all profitable invest-
ment, Jensen contends that the funds should be returned
to the company owners. However, managers may misuse
these funds to invest in unprofitable projects or perks that
maximize their own utility.
In summary, the high-debt position of the company
better aligns the interest of management with improving
the efficiency of the firm to help generate higher cash
flow. Jensen (1993) also claims that agency issues are more
likely to occur in mature industries that lack capital in-
vestment opportunities. Given HCA’s high-debt position
and large interest payments, one would expect manage-
ment to improve the overall cash flow performance of the
company.
Another theoretical perspective that complements the
agency theory is the resource-based view of Baker and
Wruck (1989) that assesses how management can improve
the productivity of the organization during the post-LBO
period. In contrast to the LBOs in the 1990s, when private
equity holders would more likely sell off assets of the com-
pany to pay off debt, the private equity companies involved
in LBOs in the 2000s operated differently. During this pe-
riod, private equity companies used their operating knowl-
edge to assist management in implementing techniques
to improve efficiency and productivity in to increase cash
flow as well as allowing management a greater control of
internal resources to support productivity activities (GAO
2008). Empirically, prior analysis of LBOs (Clement &
McCue, 1996; Opler, 1992; Opler & Titman, 1991) claim
that companies operating as an LBO focus on ways to im-
prove overall operating cash flow by reducing staffing and
capital investment.
LBOs and Operating Cash Flow
Performance
Several studies (Kaplan, 1989; Opler, 1992; Smith, 1990)
evaluated changes in operating cash flow measures of LBO
firms in the late 1980s. Kaplan (1989) evaluated 48 LBO
216 Health Care Management Review
companies over the 3-year LBO period and found sig-
nificant increases in array of financial measures, including
operating income to assets, net cash flow to sales, and net
cash flow to total assets. Smith (1990) sampled 58 com-
panies and also found positive changes in cash flow during
the LBO. Finally, Opler (1992) evaluated 44 LBO compa-
nies and found significant increases in operating cash flow
for LBOs.
During the latest boom of takeovers in the mid 2000s,
LBO companies achieved higher performance in profits
and investor returns than non-LBO firms. However, em-
pirically, studies were unable to determine if the im-
proved performance was attributable to the management
of private equity firms or that of LBO companies (Cressy
et al., 2007; GAO, 2008). In the descriptive analysis of
HCA’s LBO in 2006, McCue and Thompson (in press)
found no change pre-/post-LBO in the median value of
HCA’s operating cash flow. Given Jensen’s (1986) agency
theory view that debt better aligns management with
the interest of their owners, we would expect HCA’s cash
flow to improve during the LBO period. In addition, fol-
lowing Baker and Wruck’s (1989) resource-based perspec-
tive, we also expect the key drivers that improve HCA’s
operating efficiency and its net operating cash flow to im-
prove as well. Under an LBO, one would expect increasing
net patient revenue and declining operating expense. Fur-
thermore, the utilization of its total assets, which can be
measured by total asset turnover ratio, is also expected to
increase over the LBO period.
LBOs and Capital Investment
Firms that operate as an LBO may have limited capital
investment opportunities because of the need to allocate
its cash flow toward paying off its high-debt service re-
quirements. A publicly traded company like HCA that
utilizes an LBO to become a private entity is less likely to
be resource constrained. The basis of this premise is that
the underlying motivation of the firms that go public is
to access the public equity markets to fund future capi-
tal projects (Kim & Weisbach, 2008). Therefore, in the
case of HCA, they may have decided to go through an
LBO and become private, because their future capital
needs were limited because of fewer capital investment
opportunities.
Prior empirical analysis of LBOs in the 1980s (Kaplan,
1989; Opler, 1992; Smith, 1990) found that LBO com-
panies decreased their capital outlays during the post-
LBO periods. During the recent LBO period of the 2000s,
Aslan and Kumar (2009) found that, during the post-
LBO, firms in the United Kingdom from 1996 through
2006 decreased their capital investment but increased
their profits. Therefore, one would expect that HCA
would decrease its capital expenditures during the LBO
time frame.
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JulyYSeptember & 2012
LBOs and Staffing
Following the previously discussed resource-based views
of Baker and Wruck (1989), one would expect that LBOs
with a dominant investorVin this case, a private equity
firmVwill develop different approaches to improve pro-
ductivity. As a result, firms that increase debt position
because of LBOs are more likely to consider different ap-
proaches to reduce employment to help lower their labor
costs to pay off their debt service requirements. Empiri-
cally, Kaplan (1989) and Lichtenberg and Siegel (1990)
studied the employment levels of LBO companies during
the 1980s and found that their growth in employees was
less than that of non-LBO companies within the same in-
dustry. Davis, Haltiwanger, Jarmin, Lerner, and Miranda
(2008) analyzed LBOs within the United States from 1980
to 2005 within retail and manufacturing industries. They
found lower rates of employment growth during their LBO
period for LBOs within the retail industry and no growth in
employment for manufacturing. Although they analyzed
LBO firms within United Kingdom from 1999 to 2004,
Amess and Wright (2007) found lower growth rates in
wages for LBO firms and the same rate of growth in em-
ployment relative to non-LBO firms.
The hospital industry has greater labor intensity than
nonservice industries. Industry data indicate a capital to
labor ratio of .72, compared with .39 for nonservice in-
dustries (Culter, 2000). However, hospitals are usually
cautions about reducing their staffing levels too low, in
particular, nursing, because of its impact on patient out-
comes. Studies have found that higher staffing levels im-
prove operating performance in terms of length of stay
(Flood & Diers, 1988) and patient outcomes (Brown,
Sturman, & Simmering, 2003). In terms of nurse staffing,
studies (Kovner & Gergen, 1998; Needleman et al., 2002)
have found that lower nurse staffing levels are associated
with adverse patient outcomes, such as pneumonia, shock,
and upper gastrointestinal bleeding.
Given the labor intensity of the hospital industry as
well as the view of Baker and Wruck (1989), we would
expect HCA hospitals to reduce their full-time equivalent
(FTE) levels as well as labor costs during the LBO period.
Methods
Sample
We first identified 163 urban HCA hospitals and developed
a final sample of 121 hospitals that consistently reported
data over a 4-year window from 1 year pre-LBO to 3 years
post-LBO by employing the following sampling process.
First, because of our focus on short-term, acute care hos-
pitals, we excluded 15 HCA hospitals that were spe-
cialty facilities, specifically rehabilitation, psychiatric, and
Leveraged Buyout of HCA, Inc. 217

children’s hospitals. Second, we excluded four facilities
that were critical access hospitals because of their smaller
bed size and their Medicare reimbursement methodology,
which is on a cost basis. Finally, we excluded 23 facilities,
because they did not report the Centers for Medicare and
Medicaid Services Health Care Cost Report Information
System data for four continuous annual fiscal years from
2006 to 2009. Given that the LBO started on July 2006,
the 2006 fiscal year included fiscal year ending reporting
dates between September 30, 2005, and June 30, 2006,
which is before the LBO date. The 3-year post-LBO in-
cludes hospitals with the following fiscal years: 2007 (fiscal
years ending between September 30, 2006, and June 20,
2007), 2008 (fiscal years ending between September 30,
2007, and June 20, 2008), and 2009 (fiscal years ending
between September 30, 2008, and June 20, 2009).
Variables
Table 1 presents both dependent and independent var-
iables and their respective operational definitions. Their
mean and standard deviation values during the pre- and
post-LBO period are presented in Table 2. The eight de-
pendent variables included measures of financial and
operational performance. Cash flow margin is defined as
the percentage of cash flow from operations earned from
net patient revenue. It accounts for noncash expenses of
depreciation and for differences in capital costs by adding
back depreciation and interest expenses to net income.
Net patient revenue is calculated by subtracting contrac-
tual allowances, bad debt, and charity care from total gross
patient revenue. Operating expense is total operating ex-
pense related to provision of medical services. We took the
natural logs of net patient revenue and operating expense
in the analysis. Profit margin ratio is defined as the percent-
age of operating profit earned from net patient revenues.
Total asset turnover ratio measures how productive a hos-
pital’s total assets are in generating net patient revenue.
With regard to measuring the level of capital investment,
the net fixed asset per bed is calculated as the purchase price
of the asset (gross fixed asset) less the accumulated depre-
ciation (the sum of the annual amounts charged for the
depreciation of the asset) divided by staffed beds. Staffing
is measured by FTE, which measures the amount of labor

Table 1

List of variables, definitions, and sources

Variable Definition Source

Dependent variables
Cash flow margin (Net income + depreciation + interest expense) / net patient revenue HCRIS
Net patient revenue Gross patient revenue Y (contractual allowances + bad debt + charity care) HCRIS
Operating expense Total operating expense HCRIS
Profit margin ratio (Net patient revenue Y operating expense) / net patient revenue HCRIS
Total asset turnover ratio Net patient revenue  total assets HCRIS
Net fixed assets per bed (Gross fixed assets Y accumulated depreciation)  staffed beds HCRIS
Salary expense per Total salary and benefit expense  total operating expense HCRIS
operating expense
Number of FTEs per census Number of FTEs of staffs / occupied beds HCRIS
Independent variables
LBO dummy 1 = post-LBO; 0 = pre-LBO
Number of beds Number of staffed beds AHA
Number of adjusted Total discharges  (gross patient revenue  gross inpatient revenue) AHA
discharges
Case mix index Medicare case mix index HCRIS
Occupancy rate Inpatient days / (staffed beds  365) HCRIS
Medicare payer mix Medicare discharges / total discharges HCRIS
Medicaid payer mix Medicaid discharges / total discharges HCRIS
Teaching hospital 1, if Member of Council of Teaching Hospital; 0, otherwise AHA
HirshmanYHerfindahl index Squared sum of (adjusted discharges / total adjusted discharges for AHA
the market)
Per capita income Market level per capita income BEA
Medicare advantage Percentage of Medicare advantage enrollees in market KSHF
penetration rate
Note. AHA = American Hospital Association Annual Survey; BEA = Bureau of Economic Analysis; FTE = full-time equivalent; HCRIS = Medicare’s
Health Care Cost Report Information System; KSHF = Kaiser State Health Facts; LBO = leveraged buyout.

Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
218 Health Care Management Review JulyYSeptember & 2012

Table 2

Summary statistics of study variables for HCA hospitals during the pre- and post-LBO
period (n = 121)
Pre-LBO Post-LBO
2006 2007 2008 2009

Mean (SD) Mean (SD) Mean (SD) Mean (SD)

Dependent variables
Cash flow margin 0.13 (0.13) 0.13 (0.13) 0.13 (0.13) 0.14 (0.14)
Net patient revenue ($million) 166.46 (119.29) 175.58 (126.58) 184.97 (128.33) 200.29 (144.33)
Operating expense ($million) 149.34 (99.46) 155.48 (105.69) 164.24 (111.17) 176.35 (123.68)
Profit margin ratio 0.07 (0.14) 0.08 (0.15) 0.08 (0.14) 0.09 (0.15)
Total asset turnover ratio 1.56 (0.55) 1.77 (0.91) 1.80 (0.97) 1.96 (1.06)
Net fixed assets per bed ($1,000) 288.40 (145.41) 286.26 (138.12) 309.19 (171.23) 304.25 (161.47)
Salary expense per operating expense 0.32 (0.04) 0.32 (0.04) 0.33 (0.05) 0.32 (0.05)
Number of FTEs per census 6.24 (1.69) 6.10 (1.52) 6.13 (1.77) 6.22 (1.65)
Independent variables
Number of beds 240.21 (154.97) 240.31 (153.06) 243.62 (156.68) 248.23 (162.35)
Number of adjusted discharges (100) 175.57 (107.87) 180.80 (111.03) 180.33 (112.08) 188.19 (122.13)
Case mix 1.46 (0.18) 1.45 (0.19) 1.48 (0.17) 1.51 (0.18)
Occupancy rate 0.63 (0.16) 0.63 (0.16) 0.63 (0.16) 0.62 (0.15)
Medicare payer mix 0.38 (0.13) 0.36 (0.13) 0.35 (0.13) 0.34 (0.13)
Medicaid payer mix 0.11 (0.09) 0.11 (0.09) 0.10 (0.09) 0.10 (0.09)
Teaching hospital 0.02 (0.13) 0.02 (0.13) 0.02 (0.13) 0.02 (0.13)
HirshmanYHerfindahl index 0.21 (0.19) 0.21 (0.19) 0.21 (0.19) 0.21 (0.19)
Per capita income ($100) 355.73 (75.80) 380.68 (87.33) 392.59 (88.75) 395.98 (86.84)
Medicare advantage penetration rate 0.14 (0.14) 0.18 (0.13) 0.21 (0.13) 0.23 (0.12)
Note. FTE = full-time equivalent.

per occupied bed, in providing hospital care. Labor costs
are measured by salary expenses as a percentage of total
expenses.
The key independent variable of interest in each re-
gression model is the binary LBO variable, with the value
of 1 indicating HCA hospitals in the post-LBO period and
0 indicating HCA hospitals in the pre-LBO period. Prior
research (Clement & McCue, 1996; Hoerger, 1991) eval-
uating hospital performance included several control var-
iables. To control for competition and demand effects,
we included the Herfindahl index, care penetration, and
per capita income variables. To control for case mix, payer
mix, and size, we included Medicare case mix index,
Medicare and Medicaid discharges as a percentage of to-
tal discharges, and hospital bed size. Hospital output also
was accounted for by adjusted discharges as well as hospi-
tal occupancy rate.
Analysis
To determine whether the LBO led to performance
changes, we estimated performance functions for the en-
tities and assessed whether the performance functions of
post-LBOs are different than those of pre-LBOs. With
the 4-year panel (1 year pre-LBO and 3 years post-LBO),
financial and operating performance variables were re-
gressed on the LBO dummy variable (i.e., 1 = post-LBO;
0 = pre-LBO) as well as market and hospital specific char-
acteristics. We used ordinary least squares and fixed effects
regressions, which address the effect of unmeasured and
time-invariant characteristics.
Findings
Results for the dependent variables (i.e., financial and
operating performance measures) are shown in Table 3.
Each column in Table 3 provides the coefficients on the
LBO dummy and the other variables included in the or-
dinary least squares with fixed effects regressions. First of
all, the coefficient on LBO was statistically significant in
Column 1, and it translates to a 2% increase in the cash
flow margin among HCA hospitals during the post-LBO
period compared with the pre-LBO period. The finding,
however, suggests that the rate of growth of HCA’s cash
flow margin during the post-LBO period was relatively

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Leveraged Buyout of HCA, Inc. 219

Table 3

Ordinary least squares with fixed effects regression of financial and operational
performance (n = 121)
1 2 3 4 5 6 7 8
Net fixed Salary
Log of Log of Profit assets expense per
Cash flow net patient operating margin Total asset per bed operating FTE per
Variables margin revenue expense ratio turnover ($10,000) expense census

LBO 0.020* 0.052*** 0.047*** 0.009 0.158* 0.004 0.052 0.022

(0.010) (0.015) (0.012) (0.011) (0.079) (0.003) (0.126) (0.047)
Number of j0.003 0.241*** 0.220*** 0.023 0.124 0.004 j0.910*** 0.044
beds (100) (0.018) (0.028) (0.023) (0.021) (0.147) (0.006) (0.235) (0.088)
Adjusted discharges 0.000 0.001** 0.001* 0.000 j0.000 j0.000** j0.002 j0.000
(10,000) (0.000) (0.000) (0.000) (0.000) (0.002) (0.000) (0.002) (0.001)
Adjusted case mix j0.026 0.124 0.129 j0.017 j0.086 0.005 0.594 j0.031
(0.057) (0.089) (0.073) (0.066) (0.473) (0.020) (0.755) (0.282)
Occupancy rate 0.115 0.854*** 0.678*** 0.179* 0.650 0.007 j4.778*** 1.391***
(0.064) (0.099) (0.082) (0.074) (0.531) (0.022) (0.847) (0.317)
Medicare payer mix 0.149 0.288 j0.015 0.305* 0.254 0.022 2.017 j0.034
(0.111) (0.171) (0.141) (0.128) (0.910) (0.038) (1.453) (0.543)
Medicaid payer mix j0.063 0.089 0.117 j0.035 j0.756 j0.021 0.393 0.267
(0.070) (0.109) (0.090) (0.081) (0.579) (0.024) (0.925) (0.346)
Teaching hospital 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Herfindahl index j0.052 j0.024 0.058 j0.083 j0.432 j0.133 j1.042 0.572
(0.254) (0.389) (0.321) (0.291) (2.074) (0.087) (3.312) (1.238)
Log of per j0.154 j0.058 j0.086 j0.028 0.458 j0.043 j3.393** j0.027
capita income (0.096) (0.146) (0.121) (0.110) (0.781) (0.033) (1.247) (0.466)
Medicare advantage 0.001 0.001 j0.001 0.002 0.006 j0.000 0.023* j0.007
penetration rate (0.001) (0.002) (0.001) (0.001) (0.008) (0.000) (0.013) (0.005)
D2008 0.002 0.044*** 0.049*** j0.000 j0.001 0.002 0.103 0.093*
(0.007) (0.011) (0.009) (0.009) (0.061) (0.003) (0.097) (0.036)
D2009 0.009 0.113*** 0.108*** 0.009 0.150* 0.003 0.192 0.114*
(0.009) (0.014) (0.012) (0.010) (0.074) (0.003) (0.119) (0.044)
Constant 1.636* 17.765*** 18.306*** 0.043 j3.752 0.807** 45.455** 11.814*
(1.002) (1.557) (1.285) (1.167) (8.312) (0.347) (13.272) (4.960)
Standard errors are in parentheses. FTE = full-time equivalent; LBO = leveraged buyout.
*p G.05.
**p G.01.
***p G.001.

small, considering that HCA was facing such a high de-
gree of leverage.
Next, the coefficients on LBO were statistically sig-
nificant and positive in both Columns 2 and 3. Because
we took the logs of net patient revenues and operating
expenses, the results indicate that both net patient reve-
nues and operating expenses increased by 5.2% and 4.7%,
respectively, during the post-LBO period than the pre-LBO
period. However, the coefficient on LBO in Column 4,
which shows the results for the dependent variable profit
margin ratio was not statistically significant. These results
suggest that HCA hospitals earned more patient revenues
because they also spent more during the post-LBO period
than during the pre-LBO period; their profit margin ratio
may have not increased significantly.
In Column 5, the LBO variable shows a statistically
significant and positive coefficient. Specifically, the total
asset turnover ratio of HCA hospitals increased by 15.8%
during the post-LBO period. It may indicate that HCA
hospitals became more efficient in using the organization’s
assets to generate higher revenues during the post-LBO
period.
In the remaining Columns 6, 7, and 8, the LBO var-
iable was not statistically significant. The positive but not
significant coefficient on LBO in the regression for the
dependent variable net fixed assets per bed indicates that,

Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
220 Health Care Management Review
contrary to our expectation, HCA hospitals did not expe-
rience a significant reduction in the rate of investments
in the fixed assets during the post-LBO period. In addition,
the LBO variable was neither statistically significant in
the regression for the costs associated with labor services
measured by salaries as a percentage of total expense nor
statistically significant in the regression for the ratio of
FTEs per census. This outcome suggests that HCA hospi-
tals did not reduce their labor costs and staffing levels fol-
lowing the LBO.
Discussion
During the post-LBO period, HCA hospitals needed to
allow a substantial portion of cash flow from operations
to be dedicated to the payment of principal and interest
on their indebtedness. Our study found a relatively small
increase in the cash flow margin, but it may be because of
the fact that HCA’s cash flow margin was already high in
the pre-LBO period, with 13%. The ability of the facil-
ities to continue producing a high cash flow margin during
both the pre-and post-LBO period may have been one of
the most important factors that the private equity investors
considered.
The findings of this study also suggest that HCA man-
agers have literally relied on a growth strategy. The HCA
hospitals generated significant increases in patient revenues
and operating expenses during the LBO period, which also
included a major economic recession in 2008. At the hos-
pital level, patient revenues may have increased from a
host of volume-driven factors ranging from recruiting new
physicians, improving customer service, and offering new
services (Securities Exchange Commission, 2011). In ad-
dition, many of the HCA hospitals may have been located
in favorable markets with patients that are able to pay for
their services and in high-growth regions with high pro-
portions of older people. Theoretically, the findings of this
study also support Jensen’s (1986) agency theory, wherein
the high-debt position forced management to improve the
operating cash flow of its hospitals and the improvement
of its patient revenues more than likely contributed to gen-
erating high cash flow and aligning management’s interest
with its owners.
Unlike our expectation that, with an unprecedented
amount of debt, HCA hospitals would be forced to trim
capital expenditures to save a source of cash, the level of
capital investment of HCA hospitals did not change sig-
nificantly during the post-LBO period. This outcome is a
direct contrast to HCA’s first LBO in 1989, which found
that senior management and private equity managers sold
off HCA assets, specifically its health insurance company,
hospital contract management subsidiary, clinical labora-
tory subsidiary, and eight U.S. acute-care hospitals to gen-
erate cash flow to pay off its corporate debt (Clement &
Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
JulyYSeptember & 2012
McCue, 1996). It is also different than the findings of
the LBO studies in the 1980s (Kaplan, 1989; Opler, 1992;
Smith, 1990) and the study of Aslan and Kumar (2009),
which found a decline in capital investment during the
LBO periods in the 2000s.
The finding that there is no significant change in the
capital investment also supports that the increase in the
total asset turnover ratio stems from the generation of in-
creasing patient revenues from HCA hospitals, not from a
lack of investment in their asset base. The high-debt bur-
den of the LBO may have not adversely affected the ability
of HCA to invest in the plant and equipment of its hos-
pitals. Instead, this time, it appears that the private equity
owners of the company have been focusing on improving
patient revenues of hospitals rather than stripping assets to
generate cash flow.
Although we expected that the improved financial per-
formance of HCA hospitals during the post-LBO period-
would be achieved at the expense of the employees, we did
not find any significant reduction in the staffing and em-
ployee expenses. This outcome is different from Davis et al.’s
(2008) finding on decreased employment growth for LBOs
within the retail industry during the 2000s.
There are some limitations to our study that are impor-
tant to mention. We were unable to identify a more valid
measure of each hospital’s capital expenditure, because the
Medicare cost report data no longer contain this infor-
mation. Thus, we used a proxy measure of net fixed asset
per bed. In addition, the reporting of Health Care Cost
Report Information System data, specifically, interest and
depreciation expenses, may not be as reliable as audited
financial statements (Kane & Magnus, 2001).
Practice Implications
The findings of this study have several managerial im-
plications. Given that the hospital industry is a mature line
of business and provides health care services to an aging
population, as the economy recovers and credit markets
improve, demand for health care deals by private equity
firms may increase. Therefore, one may expect other pub-
licly traded hospital companies to consider an LBO. How-
ever, the financing of health reform by reducing future
payments to Medicare, which accounts for 40%Y50% of
hospital revenues (AHA News, 2011), may require inves-
tors to bet on companies that can deliver greater efficiency
demanded by policymakers and employers seeking relief
from the rising health care costs.
In light of the above, there are several lessons to be
learned from the LBO of HCA. First, if an operator of
hospitals is considering an LBO, it must determine whether
it does have the ability and strategies to successfully gen-
erate sufficient cash flow to pay down the high-debt po-
sition. At the corporate level, HCA was able to continue to
Leveraged Buyout of HCA, Inc.
produce a high cash flow margin from operations and to
improve cash flow efficiencies by centralizing their busi-
ness operations related to purchasing, billing, collections,
and health information systems (Cowan, 2011; Securities
Exchange Commission, 2011). However, simply relying on
more efficient operations or cost-cutting strategies may
not be sufficient enough under an LBO transaction. There-
fore, an operator of hospitals would also need to build the
avenues that increase patient volume. An LBO may afford
privately held hospitals the opportunity to focus on a growth
strategy. Because their private equity investors are locked-in
for multiple years, they may be more amenable to long-term
growth strategies without having to worry about nitpicky
shareholders who are more focused on quarterly financials
than on long-term strategies.
Second, the management of hospitals that considers
an LBO should determine if it would be able to continue
investing in its facilities to keep physicians loyal and to
maintain existing revenue and add incremental volume.
A higher level of capital spending is necessary in today’s
competitive environment, and HCA’s ability to fund its
capital investment did not appear to be limited by the
LBO transaction. In addition, the management should
monitor if the high degree of leverage would limit its abil-
ity to keep investing in the training and retention of em-
ployees, which ultimately improves the quality of care and
enhances operational efficiency. The HCA’s substantial
leverage, based on this study, did not appear to adversely
affect its employees during the post-LBO period. If an op-
erator of hospitals fails to recruit and retain qualified man-
agement and employees because of the substantial leverage
after an LBO transaction, its operations would be adversely
affected in the long term.
Finally, managers should be informed about the rami-
fications of an LBO. If the operating results and available
cash of HCA hospitals were insufficient to meet their
debt service obligations, they could have faced substan-
tial liquidity problems and might have been required to
dispose of material assets or operations to meet their debt
service and other obligations. In 2010, greater financial
risk was placed on HCA hospitals. In contrast to the
LBOs in the 1980s, private equity holders of HCA did
not want to wait until the initial stock offering to recover
their initial investment of $5.5 billion. Instead, they fol-
lowed the pattern of recent LBOs by issuing dividend
payments during 2010, which totaled $4.5 billion, to pay
back the investors’ initial investment. Moreover, to work
around debt covenants regarding dividend restrictions,
HCA’s last dividend payment of $1.5 billion in November
of 2010 was paid for by issuing debt from a newly formed
HCA holding company (MollenKamp, 2010). This finan-
cial decision means less cash available for their hospitals
as well as limits HCA’s debt capacity. All of these factors
may be the underlying reason why HCA has decided to
issue stock and ‘‘go public’’ again.
Copyright @ 2012 Lippincott Williams & Wilkins. Unauthorized reproduction of this article is prohibited.
221
Policy implications were also found in this study. First,
the retreat of a publicly traded hospital company from
the public market raises transparency issues. Privately held
hospitals would be outside the scrutiny of what applies
to publicly traded facilities. It is likely that there will be
less scrutiny, less information out there at a time when
not-for-profit hospitals are being told that they need to
disclose more about what they are doing. Private manage-
ment might do a better job at running the company, but
certainly, there is no protection or scrutiny available to
the public.
Second, policy makers as well as managers must un-
derstand not only the financial implications of the buy-
out transaction but also its potential impact on patients
and the community. One may be concerned that there
will be even less public accountability when an operator
of hospitals is privately owned. An LBO leaves a large
health care corporation that may be much less able to
be influenced by the community or any members of the
public. Future studies need to examine whether an LBO
arrangement of hospitals has any negative effect on the
hospitals’ service to the needs of the community.
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