Valuing Private Equity

Morten Sørensen, Neng Wang, Jinqiang Yang

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

We investigate whether the performance of private equity (PE) investments is sufficient to compensate investors (LPs) for risk, long-term illiquidity, management, and incentive fees charged by the general partner (GP).We analyze the LPs’ portfolio-choice problem and find that management fees, carried interest, and illiquidity are costly, and GPs must generate substantial alpha to compensate LPs for bearing these costs. Debt is cheap and reduces these costs, potentially explaining the high leverage of buyout transactions. Conventional interpretations of PE performance measures appear optimistic. On average, LPs may just break even, net of management fees, carry, risk, and costs of illiquidity.
We investigate whether the performance of private equity (PE) investments is sufficient to compensate investors (LPs) for risk, long-term illiquidity, management, and incentive fees charged by the general partner (GP).We analyze the LPs’ portfolio-choice problem and find that management fees, carried interest, and illiquidity are costly, and GPs must generate substantial alpha to compensate LPs for bearing these costs. Debt is cheap and reduces these costs, potentially explaining the high leverage of buyout transactions. Conventional interpretations of PE performance measures appear optimistic. On average, LPs may just break even, net of management fees, carry, risk, and costs of illiquidity.
LanguageEnglish
JournalReview of Financial Studies
Volume27
Issue number7
Pages1977-2021
ISSN0893-9454
DOIs
StatePublished - 2014

Cite this

Sørensen, M., Wang, N., & Yang, J. (2014). Valuing Private Equity. Review of Financial Studies, 27(7), 1977-2021. DOI: 10.1093/rfs/hhu013
Sørensen, Morten ; Wang, Neng ; Yang, Jinqiang. / Valuing Private Equity. In: Review of Financial Studies. 2014 ; Vol. 27, No. 7. pp. 1977-2021
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Sørensen, M, Wang, N & Yang, J 2014, 'Valuing Private Equity' Review of Financial Studies, vol. 27, no. 7, pp. 1977-2021. DOI: 10.1093/rfs/hhu013

Valuing Private Equity. / Sørensen, Morten; Wang, Neng; Yang, Jinqiang.

In: Review of Financial Studies, Vol. 27, No. 7, 2014, p. 1977-2021.

Research output: Contribution to journalJournal articleResearchpeer-review

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AB - We investigate whether the performance of private equity (PE) investments is sufficient to compensate investors (LPs) for risk, long-term illiquidity, management, and incentive fees charged by the general partner (GP).We analyze the LPs’ portfolio-choice problem and find that management fees, carried interest, and illiquidity are costly, and GPs must generate substantial alpha to compensate LPs for bearing these costs. Debt is cheap and reduces these costs, potentially explaining the high leverage of buyout transactions. Conventional interpretations of PE performance measures appear optimistic. On average, LPs may just break even, net of management fees, carry, risk, and costs of illiquidity.

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JO - Review of Financial Studies

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Sørensen M, Wang N, Yang J. Valuing Private Equity. Review of Financial Studies. 2014;27(7):1977-2021. Available from, DOI: 10.1093/rfs/hhu013