This research aims to identify the determinants of the ex-ante risk premium
required by Italian private equity funds (PEFs) when valuing privately-held
target companies. In theory, perceived risk is a key driver of expected returns
and anticipated value, but: ¿Although PE (private equity) has experienced
rapid growth, the risk and return profile of this asset class is not well
understood.¿ (Jegadeesh et al., 2009).
Some papers have attempted to assess the ex post returns pioneered by
Lerner & Gompers (1997). Yet such studies reveal both contradictory
conclusions and hitherto inexplicable phenomena: what some authors call
the ¿private equity premium puzzle¿ (Moskowitz & Jorgensen, 2000). Such
contradictory conclusions include a wide spread of abnormal realized returns
ranging from -6% (Phalippou & Gottschalg, 2009) to +32% (Cochrane, 2005).
In this research, the perceived risk and expected return drivers refer not to
the ex-post realized return that PEF investors actually achieve, but to the
required return the PEF hopes to gain from the target investment. At this
stage, two important indicators adopted in PEF parlance have to be
differentiated: (i) the Expected IRR (E.IRR) and (ii) the Threshold IRR
(T.IRR). The first is the IRR as an output of a business plan, and the second assesses the return expected by PEFs according to the risk perceived in the
business plan. Put simply, these are respectively, the anticipated return and
the (risk-adjusted) required return.
The study of the T.IRR is one of the main contributions of this thesis since it
has never been studied before by academia as an indicator of the ex-ante
perceived risk of a PEF target company. This is partly due to two important
reasons. First, most previous papers examine ex-post performance, and only
a few (e.g. Manigart et al., 2002), try to assess return expectations and risk
perceptions using an ex-ante perspective. Second, most of the prior studies
are quantitative and try to measure statistical effects captured by the ex-post
IRR.
By studying 26 deals (in 13 Italian PEFs) in detail (qualitatively and
quantitatively), this research project has been able to observe how PEFs
assess risk and estimate the T.IRR. The research project reveals that PEFs
apply neither rational-based models nor explicit formulae to assess risk exante.
By observing a set of phenomena unique to the PEF sector (fees effect,
investment speed effect, persistence effect, money-chasing deal
phenomenon, illiquidity effect, etc) whose existence has been suggested by
many recent papers, this thesis has been able to propose an adjusted
version of the three-factor model of Fama and French (1993, 1995) to assess
risk.
The application of a quasi-rational-based asset pricing model to guide PEFs
assessments is also an important contribution of this thesis. In fact, Franzoni, Nowak and Phalippou (2010), claim to be the first to calculate the PEFs¿ cost
of capital by applying asset pricing models.
However, their approaches are not only based on the observations of
realized returns, but also consider only one additional factor to the standard
Fama & French three-factor model (1993), the liquidity factor.
In contrast, the results and the model proposed by this thesis are based on
qualitative and quantitative ex-ante information and include not only the
classical factors of that model, but also some other factors intended to
explain some of the phenomena listed above which might also drive the risk
premium in private equity funds. Based, therefore, on explaining the behavior
of PEFs, the research develops a framework that can be applied by Italian
PEFs and perhaps other PEFs in a more rational manner than their past
behavior suggests.
| Identifer | oai:union.ndltd.org:BRADFORD/oai:bradscholars.brad.ac.uk:10454/5736 |
| Date | January 2011 |
| Creators | Scarpati, Fernando A. |
| Contributors | Neale, Bill |
| Publisher | University of Bradford, School of Management |
| Source Sets | Bradford Scholars |
| Language | English |
| Detected Language | English |
| Type | Thesis, doctoral, DBA |
| Rights | <a rel="license" href="http://creativecommons.org/licenses/by-nc-nd/3.0/"><img alt="Creative Commons License" style="border-width:0" src="http://i.creativecommons.org/l/by-nc-nd/3.0/88x31.png" /></a><br />The University of Bradford theses are licenced under a <a rel="license" href="http://creativecommons.org/licenses/by-nc-nd/3.0/">Creative Commons Licence</a>. |
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