A Primer on Private Equity at Work: Management, Employment, and Sustainability

Private equity, hedge funds, sovereign wealth funds and other private pools of capital form part of the growing shadow banking system in the United States; these new financial intermediaries provide an alternative investment mechanism to the traditional banking system. Private equity and hedge funds have their origins in the U.S., while the first sovereign wealth fund was created by the Kuwaiti Government in 1953. While they have separate roots and distinct business models, these alternative investment vehicles increasingly have been merged into overarching asset management funds that encompass all three alternative investments. These funds have wielded increasing power in financial and non-financial sectors – not only via direct investments but also indirectly, as their strategies – such as high use of debt to fund investments – have been adopted by investment arms of banks and by publicly-traded corporations. This primer focuses on private equity (PE) because this is the new financial intermediary that most directly affects the management of, and employment relations in, operating companies that employ millions of U.S. workers. However, as the boundaries among alternative investment funds have begun to blur, we will touch on hedge funds and sovereign wealth funds as their activities relate to private equity.private equity

Risk and expected returns of private equity investments : evidence based on market prices

We estimate the risk and expected returns of private equity investments based on the market prices of exchange traded funds of funds that invest in unlisted private equity funds. Our results indicate that the market expects unlisted private equity funds to earn abnormal returns of about one to two percent. We also find that the market expects listed private equity funds to earn zero to marginally negative abnormal returns net of fees. Both listed and unlisted private equity funds have market betas close to one and positive factor loadings on the Fama-French SMB factor. Private equity fund returns are positively correlated with GDP growth and negatively correlated with the credit spread. Finally, we find that market returns of exchange traded funds of funds and listed private equity funds predict changes in self-reported book values of unlisted private equity funds

Private Equity, Investment and Financial Constraints – Firm-Level Evidence for France and the United Kingdom

The welfare effects of private equity transactions are debated controversially. We analyze the impact of expansion financing and buyouts by private equity investors on investment of portfolio firms in the UK and France – two countries with different financial systems. Unobserved heterogeneity and the endogeneity of private equity transactions financed by venture capital companies are addressed using dynamic panel data techniques. In both countries we find that portfolio firms display higher investment levels and a lower dependence on internal funds after expansion financing. Buyouts financed by venture capital companies are neither associated with a decrease in investment spending nor with an increase in the dependence on internal finance. In contrary, private equity based buyouts in the UK outperform non-private equity backed British firms in terms of both indicators. Contrasting the notion of several policy makers,we cannot detect that private equity based buyout financing yields higher financial constraints on average.Investment, financial constraints, private equity employer-to-employer, linked employer-employee

Private equity-, stock- and mixed asset-portfolios: a bootstrap approach to determine performance characteristics, diversification benefits and optimal portfolio allocations : [Version: December 2003]

In this article, we investigate risk return characteristics and diversification benefits when private equity is used as a portfolio component. We use a unique dataset describing 642 US-American portfolio companies with 3620 private equity investments. Information about precisely dated cash flows at the company level enables for the first time a cash flow equivalent and simultaneous investment simulation in stocks, as well as the construction of stock portfolios for benchmarking purposes. With respect to the methodology involved, we construct private equity, stock-benchmark and mixed-asset portfolios using bootstrap simulations. For the late 1990s we find a dramatic increase in the extent to which private equity outperforms stock investment. In earlier years private equity was underperforming its stock benchmarks. Within the overall class of private equity, returns on earlier private equity investment categories, like venture capital, show on average higher variations and even higher rates of failure. It is in this category in particular that high average portfolio returns are generated solely by the ability to select a few extremely well performing companies, thus compensating for lost investments. There is a high marginal diversifiable risk reduction of about 80% when the portfolio size is increased to include 15 investments. When the portfolio size is increased from 15 to 200 there are few marginal risk diversification effects on the one hand, but a large increase in managing expenditure on the other, so that an actual average portfolio size between 20 and 28 investments seems to be well balanced. We provide empirical evidence that the non-diversifiable risk that a constrained investor, who is exclusively investing in private equity, has to hold exceeds that of constrained stock investors and also the market risk. From the viewpoint of unconstrained investors with complete investment freedom, risk can be optimally reduced by constructing mixed asset portfolios. According to the various private equity subcategories analyzed, there are big differences in optimal allocations to this asset class for minimizing mixed-asset portfolio variance or maximizing performance ratios. We observe optimal portfolio weightings to be between 3% and 65%

The Eclipse of Private Equity

Private equity, characterized by firms operating as privately held partnerships organizing the acquisition and 'taking private' of public companies, is currently dominating the business news due to deals growing rapidly in number and size. If the trend continues unabated, the 1989 prediction by economist Michael Jensen of 'the eclipse of the public corporation' could be proved accurate soon. This paper argues matters will work out much differently, with private equity being at least partially eclipsed. One possibility is that current market and legal conditions, which are highly congenial to public-to-private transactions, could be disrupted in ways that cause the private equity surge to stall or even go into reverse. The paper draws on history to make this point, discussing how the spectacular rise of conglomerates in the 1960s was reversed in subsequent decades and how the 1980s buyout boom led by LBO associations -- the private equity firms of the day -- collapsed. Factors that undercut conglomerate mergers and buyouts by LBO associations (e.g. the tightening of debt markets and increased regulation) potentially could do the same with the current wave of private equity buyouts, and cause at least a temporary eclipse of private equity deals. Even if conditions remain favorable to private equity, its eclipse is likely to occur in a different way. Privacy has been a hallmark of private equity, with industry leaders operating as secretive partnerships that negotiate buyouts behind closed doors and restructure portfolio companies outside the public gaze. However, assuming market conditions remain sufficiently favorable, top private equity firms, following the lead of the Blackstone Group, may well carry out public offerings. If this happens, then even if the taking private of publicly quoted companies remains a mainstream pursuit, the exercise will occur largely under the umbrella of public markets.Codes, Corporate Governance, Private Equity.

The cash flow, return and risk characteristics of private equity

Using a unique dataset of private equity funds over the last two decades, this paper analyzes the cash flow, return, and risk characteristics of private equity. We document the draw down and capital return schedules for the typical private equity fund, and show that it takes several years for capital to be invested, and over ten years for capital to be returned to generate excess returns. We provide several determining factors for these schedules, including existing investment opportunities and competition amongst private equity funds. In terms of performance, we document that private equity generates excess returns on the order of five plus percent per annum relative to the aggregate public equity market. One interpretation of this magnitude is that it represents compensation for holding a 10-year illiquid investment.

Private equity entities and conglomerates: what are the differences?

We compare the characteristics of conglomerates and private equity entities. This is done by examining the differences among their business models. We analyze the relations of the two entity types to their investors on the one hand and to their investments on the other hand. The distinguishing characteristic of private equity entities is that they pursue a stand-alone-perspective with their investment policies, meaning that they treat each investment separately. Therefore, various linkages that exist in conglomerates do not occur in private equity entities. We describe these linkages in detail. We further argue that because of the lack of these linkages in private equity entities the shareholders and debtholders of a private equity entity and its portfolio companies are not faced with the following risks that are specific for a conglomerate: the asset shifting risk, the intra-group profit risk and the capital structure risk. Finally, we define crucial evaluation criteria for identifying a private equity entity and develop a way how regulators and other persons concerned with such a task could do so. --private equity,conglomerates,investment companies

On the real effects of private equity investment: evidence from new business creation

Using a comprehensive database of European firms, we study how private equity affects the rate of firm entry. We find that private equity investment benefits new business incorporation, especially in industries with naturally higher entry rates and R&D intensity. A two standard deviation increase in private equity investment explains as much as 5.5% of the variation in entry between high-entry and low-entry industries. We address endogeneity by exploiting data on laws that regulate private equity investments by pension funds. Our results hold when we correct for barriers to entry, general access to credit, protection of intellectual property, and labor regulations. JEL Classification: G24, L26, M13firm entry, private equity, Venture Capital

Private equity minority investments in large family firms: what influences the attitude of family firm owners?

This paper extends research in the field of private equity investments in family firms. It contributes to the literature by fundamentally analyzing the decision criteria of family firm owners for using minority investments of private equity investors. This type of financing might be of great interest to family firms, as the family firm owner is able to secure majority ownership and control over the family business. Likewise, minority investments might be attractive for private equity investors, as they are mostly not leveraged and therefore independent from capital market turbulences. Using data from 21 case studies, we identify challenges induced by the family or the business that lead to the phenomenon of private equity minority investments in family firms. We find that perceived benefits and drawbacks of private equity investments are influenced by business and family characteristics. Based on pecking-order theory, resource-based view and the strategy paradigm, propositions as well as a conceptual framework are developed. --private equity,minority investments,family firms,financing,managerial resources