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Private Equity/Venture Capital

Paper Session

Friday, Jan. 6, 2023 2:30 PM - 4:30 PM (CST)

Sheraton New Orleans, Rhythms I
Hosted By: American Finance Association
  • Chair: Ayako Yasuda, University of California-Davis

Conflicting Fiduciary Duties and Fire Sales of VC-backed Start-Ups

Bo Bian
,
University of British Columbia
Yingxiang Li
,
University of British Columbia
Casimiro Nigro
,
Goethe University-Frankfurt

Abstract

This paper studies the interactions between corporate law and venture capital (VC) exits by acquisitions, an increasingly common source of VC-related litigation. We find that transactions by VC funds under liquidity pressure are characterized by (i) a substantially lower sale price; (ii) a greater probability of industry outsiders as acquirers; (iii) a positive abnormal return for acquirers. These features indicate the existence of fire sales, which satisfy VCs' liquidation preferences but hurt common shareholders, leaving board members with conflicting fiduciary duties and litigation risks. Exploiting an important court ruling that establishes the board’s fiduciary duties to common shareholders as a priority, we find that after the ruling maturing VCs become less likely to exit by fire sales and they distribute cash to their investors less timely. However, VCs experience more difficult fundraising ex-ante, highlighting the potential cost of a common-favoring regime. Overall, the evidence has important implications for optimal fiduciary duty design in VC-backed start-ups.

Portfolio Management in Private Equity

Gregory Brown
,
University of North Carolina-Chapel Hill
Celine (Yue) Fei
,
University of North Carolina-Chapel Hill
David Robinson
,
Duke University

Abstract

General Partners (GPs) in private equity face a trade-off between focusing their skills
and effort on fewer investments to earn higher returns, or investing more broadly to
reduce risk through diversification. Using a novel, deal-level dataset of 5,925 global
investments from 1999 to 2016, we show that these portfolio considerations are important for understanding fund-level private equity returns. The largest investments in PE
funds typically have the lowest returns on average, but are also the least risky. Returns
and risk are both increasing in industry or geographic concentration. And while GP
skill only accounts for 4%-6% of the total return variation of a typical investment, it accounts for more than 40% of the return variation at the fund level. These findings show
that GPs use portfolio construction, and not just deal selection, to seek risk-adjusted
fund-level returns.

Racial Diversity in Private Capital Fundraising

Johan Cassel Pegelow
,
Vanderbilt University
Joshua Lerner
,
Harvard Business School
Emmanuel Yimfor
,
University of Michigan

Abstract

Black- and Hispanic-owned funds control a very modest share of assets in the private capital industry. We find that the sensitivity of follow-on fundraising to fund performance is greater for minority-owned groups, particularly for underperforming groups. We find little support for a number of explanations for these patterns: that minority fund valuations are overstated, that minority funds encounter difficulties in hiring personnel, or that deploying capital is more difficult for these funds. We do find that the ability of minority groups to raise capital increases during periods of high racial awareness and when the chief investment officer of local public pension plans and endowments are minorities. Together, the results support the hypothesis that the modest representation of Black- and Hispanic-owned firms in private capital stems at least partially from the nature of investor demand rather than the supply of fund managers.

Bargaining with Private Equity: Implications for Hospital Prices and Patient Welfare

Tong Liu
,
University of Pennsylvania

Abstract

I use proprietary health insurance claims data covering over 60% of privately insured individuals in the United States to study the impact of private equity (PE) hospital buyouts on hospital–insurer price negotiations, health spending, and patient welfare. I apply a novel structural approach that exploits state-level regulation changes as PE entry shocks. I find that PE buyouts lead to an 11% increase in total healthcare spending for the privately insured in affected markets, driven mostly by higher bargained prices at PE-backed hospitals and price spillovers to local rivals. PE investors' superior bargaining skills account for 43% of the price and spending increases, while financial engineering and bankruptcy threats contribute 40%, changes in patient demand contribute 10%, and reduced focus on social objectives contributes 8%. Operational efficiency gains reduce spending, but only by 1%. A counterfactual ban on PE hospital buyouts would increase patient surplus by an amount equivalent to 10.7% of health expenses. If antitrust regulators who conduct merger reviews ignore PE-backed acquirers' unique features, they risk greatly underestimating the impact of hospital mergers.

Discussant(s)
Hyeik Kim
,
Ohio State University
Mark Westerfield
,
University of Washington
Michael Ewens
,
California Institute of Technology
Merih Sevilir
,
Halle Institute for Economic Research and ESMT-Berlin
JEL Classifications
  • G2 - Financial Institutions and Services