In Private Equity, Bigger Not Always Better, Study Says
Bigger is better, except when it's not-as evidenced by new research showing that large private equity firms underperform their smaller counterparts.
The report, "Giants at the Gate: On the Cross-Section of Private Equity Investment Returns," was conducted by Florencio Lopez-de-Silanes of EDHEC Business School, an institution with campuses in Europe and Asia, with co-authors Ludovic Phalippou and Oliver Gottschalg. The researchers examined PE returns using a database of 7,500 investments worldwide over a period of 40 years.
"People are surprised by the diseconomies of scale," commented Lopez-de-Silanes, referring to the report's determination that the scale of private equity firms is a significant driver of returns. "A very important point that has also been the focus of our attention is that our data allows us to understand better the mechanisms through which scale affects returns," he said, noting that the structure of PE firms matters a great deal. "Independent and less hierarchical PE firms, as well as those whose managers have more similar backgrounds, show significantly lower diseconomies of scale," he said.
Most PE investments around the world are modest in terms of equity, with the median equity investment being about $10 million, according to the research. Media hoopla over multi-billion-dollar deals notwithstanding, only 10% of the investments in the report sample involved more than $100 million of equity.
The report revealed that as PE firms scale up, larger communication costs outweigh the benefits of higher knowledge utilization rates. The authors also found substantial underperformance of investments in emerging countries, where poorer performance is exhibited across all measures, with the exception of bankruptcy rate.
For large firms and small, the notion that private equity focuses heavily on cash-rich industries is not borne out by the research data, according to the study.
More information can be found at the EDHEC Risk Institute Web site at www.edhec-risk.com.
In other news ...
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On The Move
Bruce A. Lev, CPA, has joined Nussbaum Yates Berg Klein & Wolpow LLP as a tax partner. The firm, based in Melville, N.Y., serves high-net-worth individuals, families and home offices.
Jim Embersit has joined Ernst & Young LLP's financial services office as an executive director within its advisory practice. Embersit spent 20 years at the Federal Reserve, most recently as the deputy associate director for Credit, Market, Liquidity and Operational Risk Policy in the Division of Banking Supervision and Regulation at the Board of Governors of the Federal Reserve System.
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