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Valuing Private Equity

Author

Listed:
  • Morten Sorensen
  • Neng Wang
  • Jinqiang Yang

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.

Suggested Citation

  • Morten Sorensen & Neng Wang & Jinqiang Yang, 2014. "Valuing Private Equity," The Review of Financial Studies, Society for Financial Studies, vol. 27(7), pages 1977-2021.
    • Handle: RePEc:oup:rfinst:v:27:y:2014:i:7:p:1977-2021.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu013
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G2 - Financial Economics - - Financial Institutions and Services
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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