The Price of Diversifiable Risk in Venture Capital and Private Equity

By Michael Ewens, Charles M. Jones, Matthew Rhodes-Kropf. 2013

325 citations recorded by the source corpus.

This paper demonstrates how the principal-agent problem between venture capitalists and their investors (limited partners) causes limited partner returns to depend on diversifiable risk. Our theory shows why the need for investors to motivate VCs alters the negotiations between VCs and entrepreneurs and changes how new firms are priced. The three-way interaction rationalizes the use of high discount rates by VCs and predicts a correlation between total risk and net of fee investor returns. We take our theory to a unique data set and find empirical support for the effect of the principal-agent problem on equilibrium private equity asset prices. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Subfields: Accounting, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/b46db73c51cac4183846e227793f00c3c3cd1d11

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Citations in the corpus

Local Overweighting and Underperformance: Evidence from Limited Partner Private Equity Investments (2013, background): “Notable papers include Jones and Rhodes-Kropf (2003), Ljungqvist and Richardson (2003), Cochrane (2005), Korteweg and Sorensen (2010), Quigley and Woodward (2003), Gottschalg and Phalippou (2009), and Hochberg, Ljungqvist and Vissing-Jorgensen (2010).”
Risk and Return Characteristics of Venture Capital-Backed Entrepreneurial Companies (2010, background): “A related literature estimates the risk and return of private equity and VC investments using the cash flows distributed to the limited partners (Gompers and Lerner, 1997; Jones and Rhodes-Kropf, 2003; Ljungqvist and Richardson, 2003; Kaplan and Schoar, 2005; Phalippou and Gottschalg, 2009; and Drie”
Risk-Adjusting the Returns to Venture Capital (2015, unknown): “Conversely, Phalippou and Zollo (2005), Phalippou and Gottschalg (2009), and Driessen, Lin, and Phalippou (2012) find below-market returns.”
The performance of reverse leveraged buyouts (2009, unknown): “(Jones & Rhodes-Kropf, 2003).”
Cross-sectional Variation in Stock Returns: Liquidity and Idiosyncratic Risk (2005, result): “23 As noted earlier these results are consistent with those of Lehmann (1990) who, using monthly data, also found that returns increase in idiosyncratic risk.”
Venture Capital and Other Private Equity: A Survey (2011, unknown): “(Jones and Rhodes-Kropf 2003) differ from other studies reviewed here in that they use GP estimates of value changes rather than realized returns to estimate quarterly private equity returns.”
Private Equity Performance: Returns, Persistence and Capital Flows (2005, unknown): “Jones and Rhodes-Kropf (2003) do make these calculations using the net asset values reported quarterly by Venture Economics and ﬁnd that VC funds have a market beta of 1.11 while LBO funds have a beta of 0.81.”