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  • 1. Fundraising and Regulation <ul><li>Cumming & Johan (2009, Chapter 7) </li></ul>
  • 2. Motivation <ul><li>2003 CALPERS disclosure lawsuit </li></ul><ul><li>Public pension funds must disclose venture capital and private equity returns, even on unexited investments </li></ul><ul><li>Implications for understanding determinants of, and reporting of, returns </li></ul>
  • 3. Chapter Objectives <ul><li>Examine institutional investor behavior in response to a dearth of private equity regulations </li></ul><ul><li>Examine role of reporting standards (IFRS, as well as FTK and Basel II) in shaping institutional investor attitudes towards private equity </li></ul>
  • 4. Institutional Investor 1 Venture Capital Funds Entrepreneurial Firms Fundraising Returns Supply of Investments Demand for Investments Intermediation Issues for Fundraising <ul><li>Different Types: </li></ul><ul><li>Pension </li></ul><ul><li>Insurance </li></ul><ul><li>Bank </li></ul><ul><li>And Different </li></ul><ul><li>Countries </li></ul>Pension Plan Members (you and I) Regulated (FTK, IFRS, BASEL II) (helps different types & from different regions) Scantly Regulated (e.g., no reporting standards) (discourages institutional investors) Institutional Investor 2
  • 5. Venture Capital and Private Equity Regulation <ul><li>No strict standards for valuing investments in unexited companies </li></ul><ul><li>Recent international developments [indirectly] relevant for private equity investments: </li></ul><ul><ul><li>International Financial Reporting Standards (“ IFRS ”) </li></ul></ul><ul><ul><li>(regulation of reporting standards and transparency) </li></ul></ul><ul><ul><li>b. Financieel Toetsingkader (“ FTK ”) </li></ul></ul><ul><ul><li>(regulation of portfolio management standards such as of matching assets and liabilities) </li></ul></ul><ul><ul><li>(analogous to Prudent Man Standards Rule for Pension Funds in US (ERISA 1979), which greatly stimulated US PE investment) </li></ul></ul><ul><ul><li>c. Basel II </li></ul></ul><ul><ul><li>(regulation of risk management and disclosure standards) </li></ul></ul>
  • 6. Research Questions <ul><li>Does a lack of transparency in private equity disclosures inhibit institutional investors from investing in private equity? </li></ul><ul><li>Have the IFRS, FTK and Basel II facilitated </li></ul><ul><ul><li>Investment in private equity? </li></ul></ul><ul><ul><li>International private equity investment? </li></ul></ul><ul><ul><li>The type of private equity investment (direct company, direct fund, fund or fund)? </li></ul></ul>
  • 7. Main Findings <ul><li>A comparative dearth of regulations, particularly in regards to reporting, inhibits investment in private equity </li></ul><ul><ul><li>This effect is large : if institutional investors were 20% more confident in private equity with better regulations, then they would contribute an extra 1% of their total assets (to 2.44% from a current average of 1.44%) to private equity </li></ul></ul><ul><li>IFRS, FTK and Basel II have partly facilitated institutional investor confidence in private equity, and stimulated international investment in private equity </li></ul><ul><ul><li>This effect is also statistically and economically significant (details to follow…!) </li></ul></ul>
  • 8. Data <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>Sponsors for hand collecting data: </li></ul><ul><li>AEI Brookings / Sciences Po </li></ul><ul><li>Adveq </li></ul>
  • 9. Data <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>100 participating Dutch institutions (approximately 10% of all Dutch institutional investors) </li></ul><ul><li>Extremely detailed data on their allocations to private equity, as well as other asset classes </li></ul><ul><li>Information in regards to their view on a dearth of private equity regulations, and the IFRS, FTK and Basel II </li></ul>
  • 10.  
  • 11.  
  • 12. Table 2. Panel A. Characteristics of the Institutional Investors in the Dataset Type of Financial Institution Number of Institutions in the dataset Average Assets (millions of Euros) Average Targeted Absolute Rate of Return for Private Equity Investments (%) (as at 2005) for institutions that will invest in private equity ’06-10 Average Targeted Relative Rate of Return for Private Equity Investments Relative to Public Equity (basis points) (as at 2005) for institutions that will invest in private equity 2006-2010 Pension Fund 56 € 2,942.86 10.35 286.11 Insurance Company 25 € 5,008.00 8.14 287.50 Bank / Financial Services 19 € 9,752.63 13.17 440.00 All Types of Institutional Investors 100 € 4,753.00 10.40 314.81
  • 13. Panel B. Asset Allocations (Percentage of Assets Invested in Different Asset Classes) ...Current (as at 2005) Type of Financial Institution Publicly Traded Equities Bonds Cash / Currencies Index Funds Private Equity Other Types of Alternative Investments Other Pension Fund 33.38 50.89 4.32 1.60 1.17 7.43 1.21 Insurance Company 23.80 55.72 9.56 0.48 0.73 6.23 3.48 Bank / Financial Services 27.32 48.43 5.11 0.58 1.36 16.05 1.16 All Types of Institutional Investors 29.83 51.63 5.78 1.13 1.09 8.77 1.77 … Planned (for the period 2006-2010) Type of Financial Institution Publicly Traded Equities Bonds Cash / Currencies Index Funds Private Equity Other Types of Alternative Investments Other Pension Fund 31.51 51.73 2.86 1.97 1.67 9.53 0.73 Insurance Company 24.71 59.02 2.52 2.16 0.62 8.37 2.60 Bank / Financial Services 24.95 47.59 2.68 1.05 1.86 21.34 0.53 All Types of Institutional Investors 28.56 52.77 2.74 1.85 1.44 11.48 1.16
  • 14. Table 2 (Continued) Panel C. Private Equity Investments ...Current (as at 2005) Type of Financial Institution Number of Institutions Investing in Private Equity (All Regions) Percentage of Private Equity Investments in The Netherlands Percentage of Private Equity Investments in Europe outside The Netherlands Percentage of Private Equity Investments in the U.S. Percentage of Private Equity Investments in Asia Percentage of Private Equity Investments in Rest of World Percentage of Direct Company Investments Percentage of Direct Fund Investments Percentage of Fund of Fund Investments Pension Fund 14 23.00 43.43 25.71 4.86 3.00 8.57 41.86 49.57 Insurance Company 7 26.71 49.43 23.86 0.00 0.00 23.57 52.86 23.57 Bank / Financial Services 8 13.38 44.75 28.13 0.63 0.63 36.88 19.00 31.63 All Types of Institutional Investors 29 21.24 45.24 25.93 2.52 1.62 20.00 38.21 38.34 … Planned (for the period 2006-2010) Type of Financial Institution Number of Institutions Investing in Private Equity (All Regions) Percentage of Private Equity Investments in The Netherlands Percentage of Private Equity Investments in Europe outside The Netherlands Percentage of Private Equity Investments in the U.S. Percentage of Private Equity Investments in Asia Percentage of Private Equity Investments in Rest of World Percentage of Direct Company Investments Percentage of Direct Fund Investments Percentage of Fund of Fund Investments Pension Fund 19 13.00 52.42 28.58 3.21 2.79 6.32 36.58 57.11 Insurance Company 8 35.00 40.00 23.75 1.25 0.00 32.25 31.50 36.25 Bank / Financial Services 8 10.63 40.63 35.00 0.63 0.63 31.88 23.13 32.50 All Types of Institutional Investors 35 17.49 46.89 28.94 2.17 1.66 18.09 32.34 46.71
  • 15. <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>Empirical Tests </li></ul>
  • 16. Comparison of Means and Medians <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>Greater private equity investment where: </li></ul><ul><ul><li>Lower rank on importance of dearth of PE regulations </li></ul></ul><ul><ul><li>High rank on importance of IFRS, FTK and Basel II </li></ul></ul><ul><ul><li>Higher assets, higher PE return expectations </li></ul></ul>
  • 17. Table 4. Difference of Means and Medians Tests   Planning on Investing in Private Equity in 2006 - 2010 Not Planning on Investing in Private Equity in 2006 - 2010 Difference of Means Test Difference of Medians Test Number of Observations Mean Median Number of Observations Mean Median Assets (million Euros) 35 10114 2000 65 1866 500 3.70*** p <= 0.000***                 Rank of Importance of Dearth of Legal Restrictions 35 2.77 3 65 3.02 3 -1.55 p <= 0.014**                 FTK (2006) 35 3.40 4 65 2.17 2 5.77*** p <= 0.003*** IFRS (2005) 35 2.71 3 65 1.97 2 3.68*** p <= 0.546 Basel II (2004) 35 2.20 2 65 1.25 1 4.58*** p <= 0.008***                 Expected Return on Private Equity in Excess of Public Equity (Basis Points) 35 252.57 250 65 48.62 50 5.91*** p <= 0.000***
  • 18. Econometric Tests <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>Logit models of likelihood of PE investment </li></ul><ul><li>OLS models of extent of PE investment (relative to other asset classes) </li></ul><ul><li>OLS models of PE investment in different regions (Netherlands, Europe, US and Asia) </li></ul><ul><li>Various robustness checks </li></ul>
  • 19. Table 4.6 Panel A (see chapter for others)  Model (1) Model (2) For Models (3) – (5), the LHS percentage variable is transformed as ln (Y/(1-Y)) Model (3) Model (4) Model (5) Logit Probability of PE Allocation in 2006 – 2010 Logit Probability of PE Allocation in 2006 – 2010 OLS of % PE Allocation in 2006 – 2010 OLS of % PE Allocation in 2006 – 2010 OLS of % PE Allocation in 2006 – 2010 for subsample that was in PE in 2005 and/or will allocate to PE in 2006-2010 Marginal Effect t-statistic Marginal Effect t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic Constant -2.468 -3.483*** -0.897 -2.564** -5.914 -11.766*** -5.759 -11.524*** -3.731 -5.594*** Log (Assets) 0.199 3.231*** 0.088 1.794* 0.132 2.414** 0.121 2.442** 0.026 0.409 Log (Excess Expected Return on PE) 0.058 1.732* 0.100 2.806*** 0.029 1.991** 0.022 1.428 -0.020 -0.429 Pension Fund 0.513 2.921*** 0.136 0.992 0.472 2.660*** 0.293 1.306 0.755 3.120*** Insurance Company 0.378 1.281 0.099 0.556 0.065 0.364 -0.057 -0.275 -0.295 -1.061 Degree of Importance of Dearth of Regulations in PE -0.323 -2.597***     -0.216 -1.787*     -0.260 -1.885* Dearth of Regulations Relative Rank     -0.014 -0.854     -0.019 -0.913     FTK 0.199 2.108**     0.214 2.616***     0.222 2.257** FTK Relative Rank     0.059 2.730***     0.106 5.956***     IFRS 0.046 0.466     0.089 1.109     -0.031 -0.355 Basel II 0.370 2.601***     0.246 2.587***     0.152 1.333 Pseudo R 2 (Adjusted R 2 for Models (3) - (5)) 0.605 0.547 0.469 0.471 0.248
  • 20. <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>Conclusions </li></ul>
  • 21. Comparative Dearth of PE Regulations <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>A comparative dearth of regulations, particularly in regards to reporting, inhibits investment in private equity </li></ul><ul><ul><li>This effect is large: </li></ul></ul><ul><ul><li>20% more confident in private equity with better regulations,  contribute an extra 1% of their total assets (to 2.44% from a current average of 1.44%) to private equity </li></ul></ul>
  • 22. IFRS, FTK and Basel II <ul><li>Data </li></ul><ul><li>Empirical Tests </li></ul><ul><li>Conclusions </li></ul><ul><li>IFRS, FTK and Basel II have stimulated Private Equity investment </li></ul><ul><li>An increase in rank of importance of these factors by 20% affects: </li></ul><ul><ul><li>Investment in PE: </li></ul></ul><ul><ul><ul><li>Increases the probability of private equity investment by 16% </li></ul></ul></ul><ul><ul><ul><li>Increases the amount invested by up to 1% of total assets </li></ul></ul></ul><ul><ul><li>International investment in PE: </li></ul></ul><ul><ul><ul><li>Increases international PE investment by 0.8% of institutions’ assets </li></ul></ul></ul><ul><ul><li>Mode of PE Investment: </li></ul></ul><ul><ul><ul><li>Reduces direct fund investments by up to 0.8% of institutions’ assets </li></ul></ul></ul><ul><ul><ul><li>Increases fund-of-fund investments by up to 0.6% of institutions’ assets </li></ul></ul></ul>

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