Associate Professor of Finance
Graduate School of Management
One Shields Avenue
Davis, CA 95616-8609
ABSTRACT: We study investments in impact funds, which we define as private equity funds with a stated mandate to fund companies that generate both financial returns and positive externalities. Using data on the capital commitments of 6,000 limited partners (LPs) into 10,000 funds, we examine the effect of impact on LP’s fund choice within a general fund choice model. We focus on how fund choice varies by LP type (e.g., public pensions, foundations, endowments). Generally, prior LP-general partner (GP) relationships and LP-GP proximity are, by far, the most important determinants of LP fund choice. LP demand for impact may show up in tilts toward certain industries or locations. However, like most GP and LP attributes, fund industry and location per se do not materially affect LP fund choice. Controlling for these general determinants of fund choice, being an impact fund has a positive effect on the probability that an LP invests in the fund. The effect is only reliably large for development organizations, public pension funds, and banks. Furthermore, for most LP types, the designation of the LP being a United Nations Principles for Responsible Investment (UN PRI) signatory – a measure of demand by its constituents for impact – fails to predict investment in impact. Our findings shed light on the rich heterogeneity across LP types in the general determinants of PE investment, and the importance of impact as a fund characteristic.
With Massimo Massa, INSEAD, and Lei Zhang, NTU
ABSTRACT: We examine the effect of the bond capital supply uncertainty of institutional investors (e.g., mutual bond funds and insurance companies) on the leverage of the firm using a novel dataset. Our main finding is that the supply uncertainty of the firm’s bond investor base — measured as (i) the average portfolio turnover or (ii) the average flow volatility of investors holding the firm’s bonds, or (iii) the prevalence of mutual funds among the firm’s bondholders as opposed to insurance companies — has a negative and significant effect on the leverage of the firm. The supply uncertainty of the firm’s bond investor base also has a negative and significant effect on the firm’s probability of issuing bonds, and a positive and significant effect on the firm’s probability of issuing equity and borrowing from banks. We take a multi-pronged approach to address potential endogeneity issues, including use of geography-based instruments and firm fixed effects, subsample analyses, and a placebo test. Our results highlight the fragility of access to the bond market for companies that depend on mutual funds with high turnover / flow volatility as primary bond investors.
ABSTRACT: Using 1994–2009 data, we find that All-American (AA) analysts’ buy and sell portfolio alphas significantly exceed those of non-AAs by up to 0.6% per month after risk-adjustments for investors with advance access to analyst recommendations. For investors without such access, top-rank AAs still earn significantly higher (by 0.3%) monthly alphas in buy recommendations than others. AAs’ superior performance exists before (as well as after) they are elected, is not explained by market overreactions to stars, and is not significantly eroded after Reg-FD. Election to top-AA ranks predicts future performance in buy recommendations above and beyond other previously observable analyst characteristics. Institutional investors actively evaluate analysts and update the AA roster accordingly. Collectively, these results suggest that skill differences among analysts exist and AA election reflects institutional investors’ ability to evaluate and benefit from elected analysts’ superior skills. Other investors’ opportunity to profit from the stars’ opinions exists, but is limited due to their timing disadvantage.
If an investment bank has lucrative underwriting relationships, will its analysts necessarily produce lower quality research to the detriment of investors, because of their compromised objectivity? It is a question that academics have debated for over a decade, but one that seemed to take regulators by surprise after the bursting of the dotcom bubble in 2001, and the subsequent wave of corporate accounting scandals... Published in the Financial Times, April 2006.
ABSTRACT: We review the theory and evidence on venture capital (VC) and other private equity: why professional private equity exists, what private equity managers do with their portfolio companies, what returns they earn, who earns more and why, what determines the design of contracts signed between (i) private equity managers and their portfolio companies and (ii) private equity managers and their investors (limited partners), and how/whether these contractual designs affect outcomes. Findings highlight the importance of private ownership, and information asymmetry and illiquidity associated with it, as a key explanatory factor of what makes private equity different from other asset classes.
with Andrew Metrick, Yale School of Management
and Wonho Wilson Choi, KAIST
ABSTRACT: This paper analyzes the economics of the private equity fund compensation. We build a novel model to estimate the expected revenue to fund managers as a function of their investor contracts. In particular, we evaluate the present value of the fair-value test (FVT) carried interest scheme, which is one of the most common profit-sharing arrangements observed in practice. We extend the simulation model developed in Metrick and Yasuda (2010a) and compare the relative values of the FVT carry scheme to other benchmark carry schemes. We find that the FVT carry scheme is substantially more valuable to the fund managers than other commonly observed (and more conservative) carry schemes, largely due to the early timing of carry compensation that frequently occurs under the FVT scheme. Interestingly, conditional on having an FVT carry scheme, fund managers’ incremental gains from inflating the reported values of the funds’ un-exited portfolio companies would be negligible.
ABSTRACT: This paper examines the effects of bank relationships on underwriter choice in the Japanese corporate-bond market following the 1993 deregulation. Bank relationships have significant positive effects on a firm's underwriter choice. Relationship firms receive a small but significant fee discount and, consistent with mitigating effect of bank competition on holdup cost, multiple-relationship firms receive a significantly deeper discount than solo-relationship firms. Bank shareholding alone negatively affects underwriter choice, whereas shareholding together with loans have significantly more positive effects than loans alone. Finally, existing relationships reduce a Japanese firm's switching probability by 32%, in contrast to only 6% for U.S. firms.
ABSTRACT: We study the interim performance of private equity (PE) funds around the time of fundraising events using fund level cash flow and valuation data for over 800 funds raised between 1993 and 2009. We first show that interim performance, measured as the current fund’s percentile rank relative to its vintage year cohort funds, materially affects the PE firm’s ability to raise a follow-on fund and the size of the follow-on fund. Given these incentive results, we hypothesize and find that PE firms time their fundraising activities to coincide with periods when the current fund’s interim performance is at its peak relative to its vintage year cohorts. We further document that the size and frequency of net asset value (NAV) markdowns increases in the period following fundraising, which suggests that fund valuations are inflated during the fundraising period. Consistent with this interpretation, we find the size and frequency of markdowns increases most for small, young, and low-reputation PE firms, which have the clearest incentives to report strong interim performance. For buyout funds, we also find evidence of post-fundraising performance erosion (due to NAV inflation during fundraising) but only among the small, young, and low-reputation PE firms. Our results indicate that PE firms, particularly small, young, and low-reputation firms, are good at timing their fundraising activities to coincide with periods of peak performance and are reluctant to mark down the valuations of portfolio companies during fundraising periods.
ABSTRACT: The Financial Principles Every Venture Capitalist Needs To Master! In Venture Capital and the Finance of Innovation, future and current venture capitalists will find a useful guide to the principles of finance and the financial models that underlie venture capital decisions. Assuming no knowledge beyond concepts covered in first-year MBA course, the text serves as an innovative model for the valuation of start ups, and will familiarise you with the relationship between risk and return in venture capital, historical statistics on the performance of venture capital investments, total and partial valuation—and more.
With Alberto Manconi, Tilburg University, and
Massimo Massa, INSEAD
ABSTRACT: Using novel data on investors’ bond portfolios, we study the contagion of the crisis from securitized bonds to corporate bonds. When securitized bonds became “toxic” in August 2007, mutual funds retained the now illiquid securitized bonds and sold corporate bonds. Funds with negative flows or high liquidity needs liquidated more than others. Yield spreads increased more for corporate bonds whose pre-crisis bondholders were more heavily exposed to securitized bonds, compared to same-issuer bonds held by unexposed investors. The findings suggest that liquidity-constrained investors with exposure to securitized bonds played a role in propagating the crisis from securitized to corporate bonds.
A key culprit behind the precipitous price declines in credit markets during the financial crisis: mutual funds with short investing horizons... Published in CFO Magazine Online, July 2010.
ABSTRACT: Using 1983-2002 U.S. data, we examine whether the quality differentials in earnings forecasts between reputable and non-reputable analysts vary as the severity of conflicts of interest varies. We measure personal reputation using the Institutional Investor All-American (AA) awards, and bank reputation using Carter-Manaster ranks. While both personal reputation and bank reputation are associated with higher-quality forecasts overall, their effectiveness against conflicts of interest differs. The severity of conflicts (proxied by the aggregate volume of new equity issues) has a negative and significant effect on the performance of non-AAs at top-tier banks relative to both AAs at top-tier banks and non-AAs at lower-tier banks. In contrast, the severity of conflicts has a positive and significant effect on the performance of AAs at top-tier banks relative to both non-AAs at top-tier banks and AAs at lower-tier banks. These findings suggest that personal reputation is an effective disciplinary device against conflicts of interest, while bank reputation alone is not.
ABSTRACT: This paper analyzes the economics of the private equity industry using a novel model and dataset. We obtain data from a large investor in private equity funds, with detailed records on 238 funds raised between 1993 and 2006. We build a model to estimate the expected revenue to managers as a function of their investor contracts, and we test how this estimated revenue varies across the characteristics of our sample funds. Among our sample funds, about two-thirds of expected revenue comes from fixed-revenue components that are not sensitive to performance. We find sharp differences between venture capital (VC) and buyout (BO) funds. BO managers build on their prior experience by increasing the size of their funds faster than VC managers do. This leads to significantly higher revenue per partner and per professional in later BO funds. The results suggest that the BO business is more scalable than the VC business, and that past success has a differential impact on the terms of their future funds.
Andrew Metrick of the Yale School of Management and Ayako Yasuda of the University of California, Davis, found that private equity firms made about two-thirds of their money not from their 20 percent share of the profits but from the fees they charged to operate the companies. Published in the New York Times, January 2012.
ABSTRACT: This paper studies the effect of bank relationships on underwriter choice in the U.S. corporate-bond underwriting market following the 1989 commercial-bank entry. I find that bank relationships have positive and significant effects on a firm’s underwriter choice, over and above their effects on fees. This result is sharply stronger for junk- bond issuers and first-time issuers. I also find that there is a significant fee discount when there are relationships between firms and commercial banks. Finally, I find that serving as arranger of past loan transactions has the strongest effect on underwriter choice, whereas serving merely as participant has no effect.