Introduction to Private Equity

Abstract

Private equity markets experienced a golden age up to the second quarter of 2007 (Shadab 2009). The massive amounts of capital flowing to private equity funds up to this period are highlighted on an absolute and relative basis in Exhibits 1.1 and 1.2, respectively. This rise of the private equity mark has been attributed to the superior governance model of private equity relative to the publicly traded corporation ( Jensen 1989), regulatory costs of being a publicly traded company (see more generally, e.g., Bushee and Leuz 2005), the comparatively low price of debt finance up to the second quarter of 2007 (Acharya et al. 2007; Kaplan 2007), the rise of the hedge funds (Acharya et al. 2007; Shadab 2007) and sovereign wealth funds (Fotak et al. 2008; Bortolotti et al. 2009), among other things. The collapse in private equity since mid-2007 can be explained perhaps most directly by the collapse in credit markets and inability to effectively leverage private equity investments. Further, there are diseconomies of scale in managing private equity funds (Kanniainen and Keuschnigg 2003, 2004; Cumming 2006; Bernile et al. 2007; Cumming and Dai 2008; Cumming and Walz 2009; Lopez de Silances and Philappou 2009). Funds grew too large leading up to 2009, thereby leading to too much money chasing too few quality deals, inefficient due diligence, and too little value-added provided by fund managers. The crisis has brought on increasing calls for regulation of private equity funds (Cumming and Johan 2009), as well as hedge funds (Verret 2007; Cumming and Dai 2007, 2009) and sovereign wealth funds (Epstein and Rose 2009). In the 1980s and 1990s, there was comparatively little academic work on private equity finance. This gap in the literature was largely attributable to a dearth of systematic private equity data. More recently, however, there has been a growing number of academics who have taken an interest in the topic and have collected systematic data for empirical studies both in the U.S. context and abroad. This empirical work has in turn inspired theoretical analyses of private equity finance. As of 2009 there are a significant number of academics who have contributed greatly to our understanding of private equity markets. This book provides a comprehensive view of private equity by describing the current state of research to better understand the current state of the private equity market. The chapters herein discuss the structure of private equity funds