Working Paper: NBER ID: w14180
Authors: Alexander Ljungqvist; Matthew Richardson; Daniel Wolfenzon
Abstract: This paper analyzes the determinants of buyout funds' investment decisions. In a model in which the supply of capital is "sticky" in the short run, we link the timing of funds' investment decisions, their risk-taking behavior, and the returns they subsequently earn on their buyouts to changes in the demand for private equity, conditions in the credit market, and funds' ability to influence their perceived talent in the market. Using a proprietary dataset of 207 buyout funds that invested in 2,274 buyout targets over the last two decades, we then investigate the implications of the model. Our dataset contains precisely dated cash inflows and outflows in every portfolio company, links every buyout target to an identifiable buyout fund, and is free from reporting and survivor biases. Thus, we are able to characterize every buyout fund's precise investment choices. Our empirical findings are consistent with the model. First, established funds accelerate their investment flows and earn higher returns when investment opportunities improve, competition for deal flow eases, and credit market conditions loosen. Second, the investment behavior of first-time funds is less sensitive to market conditions. Third, younger funds invest in riskier buyouts, in an effort to establish a track record. Fourth, following periods of good performance, funds become more conservative, and this effect is stronger for younger funds.
Keywords: buyout funds; investment behavior; private equity; risk-taking; credit market conditions
JEL Codes: G11; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| improvement in investment opportunities (E22) | acceleration of investment flows of established funds (F21) |
| easing of competition (L13) | acceleration of investment flows of established funds (F21) |
| loosening of credit market conditions (E44) | acceleration of investment flows of established funds (F21) |
| market conditions (P42) | investment behavior of first-time funds (L26) |
| pressure to perform (D29) | investment in riskier buyouts by younger funds (L26) |
| periods of good performance (E32) | conservativeness of funds (G23) |
| periods of good performance (E32) | conservativeness of younger funds (G23) |