Private Equity Returns and Disclosure Around the World Douglas Cumming and Uwe Walz Hofstra Conference on Private Equity M...
Motivation: Worldwide Policy Debate <ul><li>2002 CALPERS disclosure lawsuit </li></ul><ul><ul><li>Public pension funds mus...
Research Questions <ul><li>What are the determinants of VC and private equity returns across countries? </li></ul><ul><li>...
Prior Research <ul><li>VC / PE Returns </li></ul><ul><ul><li>Cochrane (2005 Journal of Financial Economics) </li></ul></ul...
New Contributions <ul><li>First look at project-specific returns to VC and private equity across countries </li></ul><ul><...
I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
Institutional and Other Investors Venture Capital Funds Entrepreneurial Firms $ Returns $ Returns (realized vs ‘expected’)...
1. Advice, Monitoring & Returns <ul><li>Monitoring/advice activities of VC are responsible for return of VC </li></ul><ul>...
1. Advice, Monitoring & Returns (Continued) <ul><li>Hypotheses: </li></ul><ul><li>The higher the intensity of monitoring a...
2. Biases in Reporting Un-Exited Investments <ul><li>Valuation take place against trade-off between </li></ul><ul><ul><li>...
2. Biases in Reporting Un-Exited Investments (Continued) <ul><li>Hypotheses:   </li></ul><ul><li>Expected Fundraising Bene...
I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
CEPRES Dataset <ul><li>221  venture capital and private equity funds </li></ul><ul><li>72  venture capital and private equ...
 
 
Table 2. Summary Statistics and Difference Tests p <= 0.000*** -0.60 15.68 61.07 1824 0.00 77.02 2000 Country Disclosure L...
Table 2. Summary Statistics and Difference Tests (Continued) p <= 0.000*** 2.01** 20.28 62.76 1603 7.92 15.42 1173 Industr...
Table 2. Summary Statistics and Difference Tests (Continued) p <= 0.000*** -0.75 8.60 63.46 1379 0.00 91.80 1311 Initial A...
Table 3. [Condensed] Correlation Matrix -0.04 Log (Initial Investment) (19) 0.01 Standard Deviation of Cash Flows (18) 0.0...
I. Theory and Hypotheses II. Data III. Econometric Tests IV. Remarks
“ Realized Returns Econometrics” <ul><li>Multi-step Heckman correction to measure the returns to VC and private equity inv...
3-Step Heckman Correction <ul><li>Probit: Exit / No Exit </li></ul><ul><li>Selection Corrected Probit: Full / Partial Exit...
Table 4. Heckman Corrected IRR Regressions Continued… -3.2*** -0.51         -2.5** -0.41 - Log (Portfolio Size (# Investee...
Table 4. Heckman Corrected IRR Regressions (continued) Prior work: explains 1% (Cochrane, 2001) to 12% (Ljungqvist and Rih...
Unexited Reported IRRs (2000 – 2003) versus  Predicted IRRs <ul><li>Contrast  reported unexited IRRs  (as reported to the ...
Table 6. Unexited Reported IRRs  versus  Predicted IRRs Dep Var = Unexited IRR – Predicted IRR from Respective Model # Con...
3.16 4.06 2.39 3.29 Akaike Information Statistic -1740.97 -2262.49 -1307.71 -1830.18 Loglikelihood Function 91.66*** 28.10...
<ul><li>Subsample of 80 observations (investee firms) from 11 countries for which both the realized and unrealized reporte...
Continued… 0.595 1.058 -0.049 -0.085 0.309 0.070 + Log (Portfolio Size (# Investees) / General Partner) 0.043 0.045 -0.320...
5.587 5.668 5.641 2.983 Akaike Information Statistic -211.481 -209.713 -211.641 -105.336 Loglikelihood Function 2.35** 1.7...
<ul><li>Not possible to assess causality </li></ul><ul><li>but there is evidence of positive correlations between overstat...
Correlations: Overstatement of Unexited IRRs and Fundraising 0.37 0.26 Capital Under Management to Date of Fundraising 0.3...
I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
Measuring VC Returns <ul><li>Heckman selection effects are crucial </li></ul><ul><ul><li>Misspecification of model without...
Unexited IRRs Reported to Institutional Investors <ul><li>Our findings are quite remarkably(!) consistent with the proposi...
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Private Equity Returns and Disclosure Around the World

  1. 1. Private Equity Returns and Disclosure Around the World Douglas Cumming and Uwe Walz Hofstra Conference on Private Equity May 2, 2007
  2. 2. Motivation: Worldwide Policy Debate <ul><li>2002 CALPERS disclosure lawsuit </li></ul><ul><ul><li>Public pension funds must disclose venture capital and private equity returns, even on unexited investments </li></ul></ul><ul><li>Implications for understanding determinants of, and reporting of, returns </li></ul><ul><li>Do we need mandated disclosure standards for VC and PE funds? </li></ul><ul><li>Biggest issue for VC/PE markets since collapse of Internet bubble </li></ul><ul><li>Regulation of VC and PE funds one of the biggest issues in UK Financial Times last week </li></ul>
  3. 3. Research Questions <ul><li>What are the determinants of VC and private equity returns across countries? </li></ul><ul><li>Are unexited investment values over-reported to institutional investors? </li></ul><ul><li>Are biases in reporting unexited investments related to legal conditions? </li></ul><ul><li>Relative merits of alternative approaches to stimulating VC markets </li></ul>
  4. 4. Prior Research <ul><li>VC / PE Returns </li></ul><ul><ul><li>Cochrane (2005 Journal of Financial Economics) </li></ul></ul><ul><ul><li>Cumming and MacIntosh (2007 Cambridge Journal of Economics) </li></ul></ul><ul><ul><li>Hege, Palamino and Schwienbacher (2003 WP) </li></ul></ul><ul><ul><li>Lerner, Schoar and Wong (2006 Journal of Finance) </li></ul></ul><ul><ul><li>Ljungqvist and Richardson (2003 WP) </li></ul></ul><ul><li>VC Exits </li></ul><ul><ul><li>Cumming and MacIntosh (2003 Journal of Banking and Finance) </li></ul></ul><ul><ul><li>Cumming, Fleming and Schwienbacher (2006 Journal of Corporate Finance) </li></ul></ul><ul><li>VC value-added </li></ul><ul><ul><li>Cumming (2006 Journal of Business) </li></ul></ul><ul><ul><li>Gompers and Lerner (1999 MIT Press) </li></ul></ul><ul><li>No prior paper on disclosures of unexited VC returns </li></ul>
  5. 5. New Contributions <ul><li>First look at project-specific returns to VC and private equity across countries </li></ul><ul><li>Innovative application of econometric selection methods to measure VC returns </li></ul><ul><li>First look at biases in unexited returns and relations to fundraising </li></ul><ul><li>Policy implications: Reporting Standards needed in VC? </li></ul>
  6. 6. I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
  7. 7. Institutional and Other Investors Venture Capital Funds Entrepreneurial Firms $ Returns $ Returns (realized vs ‘expected’) Venture Capital Cycle E.g., CALPERS California Public Pension Fund Pension Plan Members (you and I) Reporting bias of unexited returns in annual reports? Why care? Distorted asset allocations, less overall fundraising 2-7 years before exit event (IPO, Acquisition, Write-off)  This Paper <ul><li>Cumming & </li></ul><ul><li>Johan (2007 </li></ul><ul><li>JBF) </li></ul><ul><li> CD Howe Institute, </li></ul><ul><li>AEI Sciences Po, </li></ul><ul><li>Brookings, </li></ul><ul><li>PWC, </li></ul><ul><li>EVCA, NVCA, etc. </li></ul><ul><li>They all care a lot! </li></ul>
  8. 8. 1. Advice, Monitoring & Returns <ul><li>Monitoring/advice activities of VC are responsible for return of VC </li></ul><ul><li>Main focus on VC characteristic </li></ul><ul><li>Model with asymmetric information </li></ul><ul><li>Advice is not contractible </li></ul><ul><li>IRR must be sufficiently large to induce VC to undertake optimal level of advice/monitoring </li></ul><ul><li>The more productive the VC is, the higher the optimal advice/monitoring level </li></ul><ul><ul><li> the lower the price of shares for the VC </li></ul></ul><ul><ul><li> the higher the VC returns </li></ul></ul>
  9. 9. 1. Advice, Monitoring & Returns (Continued) <ul><li>Hypotheses: </li></ul><ul><li>The higher the intensity of monitoring and advice the higher the expected IRR of the VC </li></ul><ul><ul><li>Convertible securities, syndication  higher expected rate of return </li></ul></ul><ul><ul><li>Co-investment:  lower returns </li></ul></ul><ul><ul><li>Smaller portfolios (# investments) / manager  lower returns </li></ul></ul><ul><li>Better legal environment  more efficient advice and less information asymmetries upon exit  the higher expected returns </li></ul>
  10. 10. 2. Biases in Reporting Un-Exited Investments <ul><li>Valuation take place against trade-off between </li></ul><ul><ul><li>Fundraising concerns (higher valuations potentially facilitate fundraising in next round) </li></ul></ul><ul><ul><li>Reputational concerns (overvaluation damages long-run reputation) </li></ul></ul><ul><li>Simple set-up: two projects, two VC types </li></ul><ul><li>Pooling equilibria may emerge (bad projects are overstated) </li></ul>
  11. 11. 2. Biases in Reporting Un-Exited Investments (Continued) <ul><li>Hypotheses: </li></ul><ul><li>Expected Fundraising Benefit > Expected Reputation Cost </li></ul><ul><ul><li>Inexperienced VCs: overstate </li></ul></ul><ul><ul><li>Earlier stage and high tech: overstate </li></ul></ul><ul><ul><li>Syndicated investment: less likely to overstate </li></ul></ul><ul><ul><li>Co-investment: more likely to overstate </li></ul></ul><ul><li>Legal environment increases costs of overstatement </li></ul><ul><ul><li>Less stringent accounting rules: overstate </li></ul></ul><ul><ul><li>Sarbanes Oxley: less likely to overstate </li></ul></ul>
  12. 12. I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
  13. 13. CEPRES Dataset <ul><li>221 venture capital and private equity funds </li></ul><ul><li>72 venture capital and private equity firms </li></ul><ul><li>5117 entrepreneurial firms (3826 venture capital and 1214 private equity) </li></ul><ul><li>32 years (1971 – 2003) </li></ul><ul><li>39 countries (North and South America, Europe and Asia) </li></ul><ul><li>Table 1 (see paper) defines the variables </li></ul>
  14. 16. Table 2. Summary Statistics and Difference Tests p <= 0.000*** -0.60 15.68 61.07 1824 0.00 77.02 2000 Country Disclosure Level Index < 76 p <= 0.000*** 1.20 19.05 91.96 595 5.64 18.80 621 Country Disclosure Level Index > 76 p <= 0.000*** -0.54 16.22 62.54 1773 0.00 77.92 1858 Country Earnings Aggressiveness Index < -0.383 p <= 0.000*** 1.03 18.39 85.50 646 3.17 27.43 765 Country Earnings Aggressiveness Index > -0.383 p <= 0.000*** 0.54 14.21 113.04 788 0.00 71.30 747 Legality Index < 20 p <= 0.000*** -0.87 19.26 47.23 1631 2.16 60.01 1874 Legality Index > 20 p <= 0.000*** -1.32 15.74 12.92 411 0.00 213.32 311 Risk Free Return < 3.5% p <= 0.000*** 1.36 17.41 79.59 2021 0.04 49.36 2333 Risk Free Return > 3.5% p <= 0.000*** 0.64 -10.99 108.24 511 0.00 59.07 2010 MSCI Return < 3.5% p <= 0.000*** -1.14 20.21 58.07 1908 9.32 76.88 611 MSCI Return > 3.5%                 Market and Legal Factors p <= 0.00*** 0.22 16.99 68.67 2419 0.00 63.23 2619 All Funds in the Data                 All Funds Medians Means Median IRR Average IRR # Ent Firms Median IRR Average IRR # Ent Firms PE Fund Characteristics Difference Tests Fully Realized Ent Firm Investments Unrealized / Partially realized Ent Firm Investments  
  15. 17. Table 2. Summary Statistics and Difference Tests (Continued) p <= 0.000*** 2.01** 20.28 62.76 1603 7.92 15.42 1173 Industry Market / Book < 5 p <= 0.000*** -0.55 6.08 80.27 816 0.00 101.95 1448 Industry Market / Book > 5 p <= 0.680 1.29 29.45 649.54 14 0.00 31.41 9 Publicly Listed Firm p <= 0.006*** -0.69 25.52 69.11 132 17.14 144.32 153 Other Type of Private Equity p <= 0.052* 0.37 44.72 32.73 17 13.55 27.43 30 LBO p <= 0.000*** -0.35 28.27 33.33 266 8.53 43.79 309 MBO/MBI p <= 0.000*** 1.50 25.34 121.20 116 0.00 55.77 168 Late Stage p <= 0.000*** -0.36 20.00 71.69 1119 5.09 91.80 838 Unknown Seed, Early or Expansion Stage p <= 0.000*** -0.56 14.54 28.91 226 0.00 36.40 240 Expansion Stage p <= 0.000*** -2.93*** -29.14 -1.52 424 0.00 39.55 672 Early Stage p <= 0.127 -1.65* -11.45 48.58 34 18.97 126.72 56 Start-up Stage p <= 0.097* 1.01 -2.92 520.37 71 0.00 8.88 146 Seed Stage                 Entrepreneurial Firm Characteristics p <= 0.000*** 0.87 22.07 101.38 1431 1.70 65.61 1586 Portfolio Size (# Investees) / # General Partners < 20 p <= 0.000*** -2.52** 12.34 21.29 988 0.00 59.58 1035 Portfolio Size (# Investees) / # General Partners > 20 p <= 0.000*** 0.67 -91.74 202.96 186 0.00 71.25 1391 Age of Specific PE Fund < 1795 days p <= 0.000*** 0.19 18.73 57.48 2233 9.23 54.15 1230 Age of Specific PE Fund > 1795 days p <= 0.000*** 0.29 20.27 59.11 1638 10.30 53.55 1018 Fund Number in the PE Firm < 3 p <= 0.000*** 0.34 1.51 88.72 781 0.00 69.37 1603 Fund Number in the PE Firm > 3                 Fund Characteristics Medians Means Median IRR Average IRR # Ent Firms Median IRR Average IRR # Ent Firms PE Fund Characteristics Difference Tests Fully Realized Ent Firm Investments Unrealized / Partially realized Ent Firm Investments  
  16. 18. Table 2. Summary Statistics and Difference Tests (Continued) p <= 0.000*** -0.75 8.60 63.46 1379 0.00 91.80 1311 Initial Amount Invested < $US 2,500,000 p <= 0.000*** 1.09 25.22 75.58 1040 5.04 34.62 1310 Initial Amount Invested > $US 2,500,000 p <= 0.216 -3.06*** 0.33 -5.26 1055 2.92 6.47 1418 Standard Deviation of Cash Flows to Entrepreneur / Initial $ Invested p <= 0.000*** -0.04 31.49 125.85 1364 0.00 130.12 1203 Standard Deviation of Cash Flows to Entrepreneur / Initial $ Invested p <= 0.000*** -0.95 25.99 73.62 1162 12.77 123.03 967 Convertible Security with Actual Periodic Cash Flows p <= 0.000*** 0.84 0.26 112.40 447 0.00 42.84 743 PE Board Seat(s) p <= 0.000*** 0.13 13.27 48.02 313 0.00 44.51 526 Co-Investment p <= 0.000*** 1.01 15.88 151.27 449 0.00 68.11 729 Syndicated Investment p <= 0.000*** -1.21 20.33 45.11 633 8.33 75.01 864 Lead Investment                 Investment Characteristics Medians Means Median IRR Average IRR # Ent Firms Median IRR Average IRR # Ent Firms PE Fund Characteristics Difference Tests Fully Realized Ent Firm Investments Unrealized / Partially realized Ent Firm Investments  
  17. 19. Table 3. [Condensed] Correlation Matrix -0.04 Log (Initial Investment) (19) 0.01 Standard Deviation of Cash Flows (18) 0.05 Convertible Security (17) 0.00 Board Seats (16) -0.06 Co-Investment (15) 0.06 Syndicated Investment (14) 0.07 Lead Investor (13) 0.01 Log (Industry Market / Book) (12) 0.03 Late (11) 0.03 Expansion (10) -0.03 Early (9) -0.10 Seed (8) 0.03 Log (Portfolio Size / Manager) (7) 0.04 Log (Fund Number) (6) -0.06 Log (Committed Capital) (5) 0.03 Log (Legality) (4) -0.06 Log (Interest) (3) 0.15 Log (MSCI) (2) 1.00 Log (1+IRR) (1) (1)    
  18. 20. I. Theory and Hypotheses II. Data III. Econometric Tests IV. Remarks
  19. 21. “ Realized Returns Econometrics” <ul><li>Multi-step Heckman correction to measure the returns to VC and private equity investment </li></ul><ul><li>Heckman selection corrections for </li></ul><ul><ul><li>Unexited / Exited Investments </li></ul></ul><ul><ul><li>Partial / Full Exits </li></ul></ul><ul><li>Statistical problems associated with OLS on a subsample of fully realized IRRs </li></ul>
  20. 22. 3-Step Heckman Correction <ul><li>Probit: Exit / No Exit </li></ul><ul><li>Selection Corrected Probit: Full / Partial Exit, accounting for the selection effects associated with an actual exit (step 1) </li></ul><ul><li>Heckman Linear Regression IRR, accounting for both steps # 1 and 2 </li></ul>Contrast to Cochrane (2002): moves from step # 1 to step # 3 Contrast to Ljungqvist and Richardson (2003): OLS on restricted sample of realized returns
  21. 23. Table 4. Heckman Corrected IRR Regressions Continued… -3.2*** -0.51         -2.5** -0.41 - Log (Portfolio Size (# Investees) / General Partner) -1.1 -0.14         -0.1 -0.01 + Log (Fund Number in the VC Firm)                 Fund Characteristics 5.4*** 1.31         -6.5*** -0.94 - Log (Committed Capital Overall Market at Inv Date) 2.5** 3.64 0.8 0.52     4.0*** 4.25 + Log (Legality Index) -4.6*** -27.08         -2.7*** -13.32 ? Log (Risk Free Rate) 2.1** 1.15         1.0 0.77 + Log (MSCI Return)                 Market and Legal Factors     2.5** -0.00008 24.4*** 0.0006     Duration of VC Investment (in Days) -4.0*** -20.27 -1.0 -1.80 -11.7 -0.44*** -1.5 -5.87 Constant t-statistic Coefficient t-statistic Coefficient Coefficient t-statistic t-statistic Coefficient Dependent Variable = Log(1+IRR) Dependent Variable=1 if Full Exit Dependent Variable=1 if Exit Dependent Variable = Log(1+IRR) Step 1b: Determinants of Full Exit, conditioned on step 1a regarding an actual exit Step 1a: Determinants of Exit 2nd Step Heckman Regression (Realized IRRs) 1st Step Heckman Regression: Bivariate Probit Model OLS on Subsample of Fully Realized IRRs Model (2) Model (1) Predicted Sign for Realized Returns   Panel A. Seed, Start-up, Early and Expansion Stage Investments Yes Yes No Yes Exit Year Dummies? Yes Yes No Yes Country Dummy Variables? Yes Yes  No Yes Industry Dummy Variables?
  22. 24. Table 4. Heckman Corrected IRR Regressions (continued) Prior work: explains 1% (Cochrane, 2001) to 12% (Ljungqvist and Rihardson, 2003) of variation in VC returns 5.03   5.15 Akaike Information Statistic -3373.45 -2756.44 -3456.74 Loglikelihood Function 19.65***   15.74*** F Statistic 0.35   0.29 Adjusted R 2 1358 3213 1358 Number of Observations                 Model Diagnostics -11.3*** -7.22             - Heckman Lambda B -2.3** -2.18             - Heckman Lambda A 1.9* 0.11         1.5 9.052E-02 ? Log (Amount Invested) 2.8*** 0.01         2.0** 1.200E-02 ? Standard Deviation of Cash Flows to Entrepreneur 9.9*** 1.97         13.6*** 2.43 + Convertible Security with Actual Periodic Cash Flows -2.2** -0.70         -1.2 -0.46 + VC Board Seat(s) -1.7* -0.40         -1.2 -0.30 - Co-Investment 1.7* 0.51 -3.8*** -0.42     1.3 0.34 + Syndicated Investment 0.7 0.19         0.6 0.18 ? Lead Investment                 Investment Characteristics t-statistic Coefficient t-statistic Coefficient Coefficient t-statistic t-statistic Coefficient Dependent Variable = Log(1+IRR) Dependent Variable=1 if Full Exit Dependent Variable=1 if Exit Dependent Variable = Log(1+IRR) Step 1b: Determinants of Full Exit, conditioned on step 1a regarding an actual exit Step 1a: Determinants of Exit 2nd Step Heckman Regression (Realized IRRs) 1st Step Heckman Regression: Bivariate Probit Model OLS on Subsample of Fully Realized IRRs Model (2) Model (1) Predicted Sign for Realized Returns  
  23. 25. Unexited Reported IRRs (2000 – 2003) versus Predicted IRRs <ul><li>Contrast reported unexited IRRs (as reported to the institutional investors) with predicted IRRs for unexited investments </li></ul><ul><li>Log(1+IRR Reported)-Log(1+IRR Expected) </li></ul><ul><li>= Log((1+Reported IRR)/(1+Predicted IRR) = 143% </li></ul><ul><li>Regression evidence: quite remarkably(!) consistent with the proposition that more informational asymmetry is associated with more ‘lying’! </li></ul>
  24. 26. Table 6. Unexited Reported IRRs versus Predicted IRRs Dep Var = Unexited IRR – Predicted IRR from Respective Model # Continued… Yes Yes Yes Yes Country Dummy Variables? Yes Yes Yes Yes Industry Dummy Variables? 11.1*** 0.82     10.9*** 0.49     + Log (Portfolio Size (# Investees) / General Partner) -13.5*** -1.75     -6.7*** -0.42     - Log (Age of VC Fund within the VC Firm)         Fund Characteristics -15.3*** -1.38 -8.1*** -1.07 -5.8*** -0.34 -6.2*** -0.56 - Sarbanes Oxley -3.3*** -3.18 -3.8*** -5.29 -5.4*** -0.05 -6.8*** -6.59 - Country Disclosure Level Index 4.7*** 28.95 3.5*** 37.95 9.1*** 32.38 5.9*** 42.46 + Country Earnings Aggressiveness Index -3.8*** -14.17     16.2*** 36.57     ? Log (Risk Free Rate) -9.1*** -3.11     -6.4*** -1.21     - Log (MSCI Return)         Market and Legal Factors 5.4*** 22.18 3.6*** 20.77 13.9*** 11.08 8.8*** 35.61 Constant t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (2) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (2) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel A Model (2b) Model (2a) Model (1b) Model (1a) Predicted Sign   Panel A. Seed, Start-up, Early and Expansion Stage Investments
  25. 27. 3.16 4.06 2.39 3.29 Akaike Information Statistic -1740.97 -2262.49 -1307.71 -1830.18 Loglikelihood Function 91.66*** 28.10*** 102.20*** 37.50*** F Statistic 0.70 0.25 0.74 0.36 Adjusted R 2 1122 1122 1122 1122 Number of Observations         Model Diagnostics -1.5 -0.05     -6.5*** -0.11     ? Log (Amount Invested) -2.4** -0.01     -9.7*** -0.01     ? Standard Deviation of Cash Flows to Entrepreneur -10.5*** -2.64     -19.5*** -2.46     - Convertible Security with Actual Periodic Cash Flows 5.5*** 0.68     5.7*** 0.51     ? VC Board Seat(s) 1.9* 0.17     3.8*** 0.23     + Co-Investment -8.2*** -0.75 -5.5*** -0.76 -4.2*** -0.28 -3.2*** -0.310 - Syndicated Investment 1.3 0.14     -0.7 -0.05     ? Lead Investment         Investment Characteristics t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (2) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (2) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel A Dependent Variable: Unrealized Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel A Model (2b) Model (2a) Model (1b) Model (1a) Predicted Sign   Panel A. Seed, Start-up, Early and Expansion Stage Investments
  26. 28. <ul><li>Subsample of 80 observations (investee firms) from 11 countries for which both the realized and unrealized reported IRR are known (Canada, Finland, France, Germany, Israel, Norway, Spain, Sweden, the Netherlands, the UK, and the US) </li></ul><ul><li>The correlation between out-of-sample average realized IRRs and our predicted IRRs is 0.45 </li></ul>Appendix: Compare Actual IRR to Prior Reported Unexited IRR (This is possible now in 2006!) 7.75% 15.22% Predicted IRR (Based on Table IV Model) 8.70% 98.46% Subsequently Realized Reported IRR 2.56% 219.71% Unrealized reported IRR 2.6 years 2.6 years Duration Report  Exit Median Average
  27. 29. Continued… 0.595 1.058 -0.049 -0.085 0.309 0.070 + Log (Portfolio Size (# Investees) / General Partner) 0.043 0.045 -0.320 -0.351 -1.529 -0.441 - Log (Age of PE Fund within the PE Firm) Fund Characteristics -1.420 -21.229 -2.629*** -9.577 - Country Disclosure Level Index 2.453** 375.457 2.530** 387.377 1.711* 361.277 1.166 53.544 + Country Earnings Aggressiveness Index 0.987 0.362 ? Duration from Reporting to Realization -0.054 -0.168 -0.434 -1.925 0.124 0.566 ? Log (MSCI Return Reporting Time) - Log (MSCI Return Exit Time) -0.801 -0.884 - Log (MSCI Return Reporting Time) Market and Legal Factors 2.784*** 17.299 0.907 7.729 1.517 106.795 3.035*** 52.581 Constant t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient   Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel B Dependent Variable: Dependent Variable: Dependent Variable: Dependent Variable: Model (A4) Model (A3) Model (A2) Model (A1) Predicted Sign   Table VIII. Determinants of the Difference between Reported Unrealized IRRs Disclosed to Institutional Investors and Subsequently Realized IRRs
  28. 30. 5.587 5.668 5.641 2.983 Akaike Information Statistic -211.481 -209.713 -211.641 -105.336 Loglikelihood Function 2.35** 1.74* 1.90** 20.97*** F Statistic 0.159 0.131 0.130 0.766 Adjusted R 2 80 80 80 80 Number of Observations Model Diagnostics 1.071 0.372 0.775 0.341 -1.035 -0.112 ? Log (Amount Invested) 0.032 0.005 1.102 0.081 ? Standard Deviation of Cash Flows to Entrepreneur -3.437*** -3.129 -3.317*** -3.215 -3.145*** -3.201 -10.880*** -2.703 - Convertible Security with Actual Periodic Cash Flows 0.511 0.657 0.518 0.691 -2.600*** -0.639 - Syndicated Investment Investment Characteristics Yes Yes No No Country Dummy Variables? Yes Yes Yes Yes Industry Dummy Variables? 0.042 0.051 -0.168 -0.189 0.147 0.162 2.620*** 0.673 + Log (Industry Market / Book) Entrepreneurial Firm Characteristics t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient t-statistic Coefficient   Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Subsequently Realized Log (1+IRR) Unrealized Reported Log(1+IRR) - Fitted Values from Predicted Log (1+IRR) in Model (1) of Table IV Panel B Dependent Variable: Dependent Variable: Dependent Variable: Dependent Variable: Model (A4) Model (A3) Model (A2) Model (A1) Predicted Sign  
  29. 31. <ul><li>Not possible to assess causality </li></ul><ul><li>but there is evidence of positive correlations between overstatement of unexited reported IRRs and fundraising </li></ul>Overstatement of Unexited IRRs and Fundraising
  30. 32. Correlations: Overstatement of Unexited IRRs and Fundraising 0.37 0.26 Capital Under Management to Date of Fundraising 0.33 0.21 Capital Under Management 0.39 0.24 VC Firm Age 0.27 0.18 Fund Size 1.00 0.23 Fitted Values from Difference Regression 0.23 1.00 Actual Difference Fitted Value From Difference Regression Actual Difference (Reported - Predicted IRR)  
  31. 33. I. Theory and Hypotheses II. Data III. Econometric Tests IV. Policy Implications
  32. 34. Measuring VC Returns <ul><li>Heckman selection effects are crucial </li></ul><ul><ul><li>Misspecification of model without selection effects </li></ul></ul><ul><ul><li>Like Cochrane (2002), unlike Ljungqvist & Richardson (2003), unlike Brander et al. (2002) </li></ul></ul><ul><ul><li>Multidimensional selection effects are a useful new component introduced in this paper </li></ul></ul><ul><li>VC value-added is crucial </li></ul><ul><ul><li>E.g., portfolio size / manager </li></ul></ul><ul><ul><li>Enables us to explain up to 36% of the variation in returns </li></ul></ul><ul><ul><li>Cochrane explains at most 1% using market variables only; Ljungqvist & Richardson explain up to 13% with some fund variables, but no proxies for value-added </li></ul></ul><ul><li>Legality is crucial for cross-country differences </li></ul>
  33. 35. Unexited IRRs Reported to Institutional Investors <ul><li>Our findings are quite remarkably(!) consistent with the proposition that more informational asymmetry is associated with more ‘lying’! </li></ul><ul><ul><li>for smaller ENTs, tech companies, higher earnings aggressiveness index, lower disclosure index </li></ul></ul><ul><li>Positive correlation between fundraising and lying </li></ul>

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