Interest and investment in the Private Equity (PE) asset class has grown exponentially in recent years. Advocates of the industry argue that it offers superior risk-adjusted returns compared to public market securities. Testing this theory has thus far been difficult, as we are missing both an appropriate theory to accurately describe the asset class, as well as sufficiently comprehensive data regarding PE transactions. In terms of the first constraint, certain characteristics of the segment distinguish it from the public market sector described in the prevailing capital market theory, including its illiquidity, lack of homogeneity and information asymmetry.
These characteristics are frequently highlighted as impeding the development of a suitable descriptive model. Indeed, it is the lack of transparency regarding PE transactions that is also responsible for the paucity of data upon which empirical studies could be based. This paper presents an empirical examination of PE performance drawn from a database of 5,553 PE transactions, contributed by PE funds and institutional investors. From this, detailed data regarding 133 later-stage transactions in the US was obtained giving an unprecedented source for examining the performance of individual PE transactions. In exploiting this original source, this paper seeks to make an empirical contribution to the ongoing “PE Performance Puzzle”.
There are several arguments against investing in PE assets. These focus primarily on the sector’s lack of transparency and its illiquidity. Many argue that the market does not compensate for these idiosyncratic risks and that neither the efforts of active private investors, incentives schemes nor modifications to the capital structure could improve company performance. Equally, they argue that a PE investor’s changes to the management team and governance structure have little long-term average impact on market value.
Further, they state that the efficiency of capital markets is such that no opportunities for arbitrage between the quoted and unquoted market segments exist, and that it is possible to replicate PE investment strategies using public markets instruments, thereby saving on transaction costs and management time. Also, as private company valuations follow the public market, the public market remains their primary performance driver.