Hostname: page-component-78c5997874-s2hrs Total loading time: 0 Render date: 2024-11-15T06:48:19.806Z Has data issue: false hasContentIssue false
  • English
  • Français

Giants at the Gate: Investment Returns and Diseconomies of Scale in Private Equity

Published online by Cambridge University Press:  12 August 2015

Florencio Lopez-de-Silanes ,
Ludovic Phalippou  and
Oliver Gottschalg
Florencio Lopez-de-Silanes*
Affiliation:
florencio.lopezdesilanes@edhec.edu, EDHEC Business School, Nice 06202, France and National Bureau of Economic Research
Ludovic Phalippou
Affiliation:
ludovic.phalippou@sbs.ox.co.uk, University of Oxford, Said Business School, Oxford OX1 1HP, United Kingdom
Oliver Gottschalg
Affiliation:
gottschalg@hec.fr, HEC Paris (Groupe HEC), Strategy and Business Policy, Jouy-en-Josas Cedex 78351, France.
*
*Corresponding author: florencio.lopezdesilanes@edhec.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

We document the wide dispersion of private equity investment returns and examine performance determinants using a newly constructed database of 7,500 investments worldwide. One in 10 investments does not return any money, whereas 1 in 4 has an internal rate of return (IRR) above 50%. Quick flips are associated with the highest returns. Performance does not appear scalable: Investments held by private equity firms in periods with a high number of simultaneous investments underperform substantially. Results are consistent with the theoretical literature on organizational diseconomies linked to firm structure. Private equity firms’ actions do not appear to be mechanical or easily scalable.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 50 , Issue 3 , June 2015 , pp. 377 - 411
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Acharya, V.; Gottschalg, O.; Hahn, M.; and Kehoe, C.. “Corporate Governance and Value Creation: Evidence from Private Equity.” Review of Financial Studies, 26 (2013), 368–402.CrossRefGoogle Scholar
Axelson, U.; Jenkinson, T.; Strömberg, P.; and Weisbach, M. S.. “Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts.” Journal of Finance, 68 (2013), 2223–2267.Google Scholar
Berk, J. B., and Green, R. C.. “Mutual Fund Flows and Performance in Rational Markets.” Journal of Political Economy, 112 (2004), 1269–1295.Google Scholar
Bernile, G.; Lyandres, E.; and Cumming, D.. “The Size of Venture Capitalists’ Portfolios: Theory and Evidence.” Journal of Corporate Finance, 13 (2007), 564–590.Google Scholar
Bernstein, S.; Lerner, J.; Sorensen, M.; and Strömberg, P.. “Private Equity and Industry Performance.” National Bureau of Economic Research Working Paper No. 15632 (2010).Google Scholar
Bolton, P., and Dewatripont, M.. “The Firm as a Communication Network.” Quarterly Journal of Economics, 4 (1994), 809–839.CrossRefGoogle Scholar
Bottazzi, L.; Da Rin, M.; and Hellmann, T.. “Who Are the Active Investors? Evidence from Venture Capital.” Journal of Financial Economics, 89 (2008), 488–512.CrossRefGoogle Scholar
Chen, J.; Hong, H.; Huang, M.; and Kubik, J. D.. “Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization.” American Economic Review, 94 (2004), 1276–1302.CrossRefGoogle Scholar
Chung, W.; Sensoy, B.; Stern, L.; and Weisbach, M.. “Pay for Performance from Future Fund Flows: The Case of Private Equity.” Review of Financial Studies, 25 (2012), 3259–3304.CrossRefGoogle Scholar
Cumming, D. J., and Dai, N.. “Fund Size, Limited Attention, and Valuation of Venture Capital Backed Firms.” Journal of Empirical Finance, 18 (2011), 2–15.CrossRefGoogle Scholar
Demiroglu, C., and James, C. M.. “The Role of Private Equity Group Reputation in LBO Financing.” Journal of Financial Economics, 96 (2010), 306–330.CrossRefGoogle Scholar
Fulghieri, P., and Sevilir, M.. “Size and Focus of a Venture Capitalist’s Portfolio.” Review of Financial Studies, 22 (2009), 4643–4680.Google Scholar
Fung, W.; Hsieh, D. A.; Naik, N. Y.; and Ramadorai, T.. “Hedge Funds: Performance, Risk, and Capital Formation.” Journal of Finance, 63 (2008), 1777–1803.Google Scholar
Garicano, L. “Hierarchies and the Organization of Knowledge in Production.” Journal of Political Economy, 108 (2000), 874–904.Google Scholar
Gompers, P. “Grandstanding in the Venture Capital Industry.” Journal of Financial Economics, 42 (1996), 133–156.CrossRefGoogle Scholar
Gompers, P.; Kovner, A.; Lerner, J.; and Scharfstein, D.. “Venture Capital Investment Cycles: The Impact of Public Markets.” Journal of Financial Economics, 87 (2008), 1–23.CrossRefGoogle Scholar
Gompers, P.; Kovner, A.; Lerner, J.; and Scharfstein, D.. “Specialization and Success: Evidence from Venture Capital.” Journal of Economics and Management Strategy, 18 (2009), 817–844.Google Scholar
Gompers, P., and Lerner, J.. “Money Chasing Deals? The Impact of Fund Inflows on Private Equity Valuations.” Journal of Financial Economics, 55 (2000), 281–325.Google Scholar
Hardymon, F.; Leamon, A.; and Lerner, J.. Venture Capital and Private Equity: A Casebook. Hoboken, NJ: John Wiley & Sons (2004).Google Scholar
Harris, R. S.; Jenkinson, T.; and Kaplan, S.. “Private Equity Performance: What Do We Know?” Journal of Finance, 69 (2014), 1851–1882.CrossRefGoogle Scholar
Hochberg, Y. V.; Ljungqvist, A.; and Vissing-Jorgensen, A.. “Informational Hold-Up and Performance Persistence in Private Equity.” Review of Financial Studies, 27 (2014), 102–152.CrossRefGoogle Scholar
Hochberg, Y. V., and Westerfield, M.. “The Size and Specialization of Direct Investment Portfolios.” Working Paper, Northwestern University (2009).Google Scholar
Holmström, B., and Roberts, J.. “The Boundaries of the Firm Revisited.” Journal of Economic Perspectives, 12 (1998), 73–94.Google Scholar
Humphery-Jenner, M. “Private Equity Fund Size, Investment Size, and Value Creation.” Review of Finance, 6 (2012), 799–835.Google Scholar
Ivashina, V., and Kovner, A.. “The Private Equity Advantage: Leveraged Buyout Firms and Relationship Banking.” Review of Financial Studies, 24 (2011), 2462–2498.Google Scholar
Jones, C. M., and Rhodes-Kropf, M.. “The Price of Diversifiable Risk in Venture Capital and Private Equity.” Working Paper, Columbia University(2004).Google Scholar
Kanniainen, V., and Keuschnigg, C.. “The Optimal Portfolio of Start-Up Firms in Venture Capital Finance.” Journal of Corporate Finance, 9 (2003), 521–534.CrossRefGoogle Scholar
Kaplan, S. N., and Lerner, J.. “It Ain’t Broke: The Past, Present, and Future of Venture Capital.” Journal of Applied Corporate Finance, 22 (2010), 36–47.Google Scholar
Kaplan, S. N., and Schoar, A.. “Private Equity Performance: Returns, Persistence, and Capital Flows.” Journal of Finance, 60 (2005), 1791–1823.Google Scholar
Kaplan, S. N., and Strömberg, P.. “Leveraged Buyouts and Private Equity.” Journal of Economic Perspectives, 23 (2009), 121–146.Google Scholar
Lerner, J., and Schoar, A.. “Does Legal Enforcement Affect Financial Transactions? The Contractual Channel in Private Equity.” Quarterly Journal of Economics, 120 (2005), 223–246.Google Scholar
Lerner, J.; Schoar, A.; and Wong, W.. “Smart Institutions, Foolish Choices: The Limited Partner Performance Puzzle.” Journal of Finance, 62 (2007), 731–764.Google Scholar
Ljungqvist, A.; Richardson, M.; and Wolfenzon, D.. “The Investment Behavior of Buyout Funds: Theory and Evidence.” Working Paper, New York University (2007).Google Scholar
Metrick, A. Venture Capital and the Finance of Innovation. Hoboken, NJ: John Wiley & Sons (2007).Google Scholar
Phalippou, L. “Performance of Buyout Funds Revisited?” Review of Finance, 18 (2014), 189–218.Google Scholar
Pollet, J. M., and Wilson, M.. “How Does Size Affect Mutual Fund Behavior?” Journal of Finance, 63 (2008), 2941–2969.CrossRefGoogle Scholar
Quindlen, R. Confessions of a Venture Capitalist: Inside the High-Stakes World of Start-Up Financing. New York, NY: Warner Books (2000).Google Scholar
Robinson, D. T., and Sensoy, B. A.. “Cyclicality, Performance Measurement and Cash Flow Liquidity in Private Equity.” Working Paper, Charles A. Dice Center (2011).CrossRefGoogle Scholar
Robinson, D. T., and Sensoy, B. A.. “Do Private Equity Fund Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance.” Review of Financial Studies, 26 (2013), 2760–2797.Google Scholar
Stein, J. C. “Information Production and Capital Allocation: Decentralized versus Hierarchical Firms.” Journal of Finance, 42 (2002), 1891–1921.Google Scholar
Strömberg, P. “The New Demography of Private Equity.” In Globalization of Alternative Investment Working Papers Volume 1, The Global Economic Impact of Private Equity Report 2008. Geneva, Switzerland: World Economic Forum (2008).Google Scholar
Swensen, D.; Takahashi, D. J.; Sullivan, T. R.; Fonnan, A. S.; and Alexander, S. D.. “Private Equity.” Portfolio Review, 7 (Oct. 1999).Google Scholar
Teo, M. “Does Size Matter in the Hedge Fund Industry?” Working Paper, available at http://ssrn.com/abstract=1331754 or http://dx.doi.org/10.2139/ssrn.1331754 (2009).CrossRefGoogle Scholar
Vayanos, D. “The Decentralization of Information Processing in the Presence of Interactions.” Review of Economic Studies, 70 (2003), 667–695.Google Scholar
Williamson, O. Markets and Hierarchies: Analysis and Antitrust Implications. New York, NY: Free Press (1975).Google Scholar