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Private equity returns and disclosure around the world

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Abstract

To obtain more funds from the institutional investors, private equity (PE) fund managers may report inflated valuations of private investee companies that are not yet sold. However, such overvaluations may result in a reputational cost when those investments are realized. Using evidence from 39 countries, we show that there are significant systematic biases in managers' reporting of fund performance. We find that these biases depend on the accounting and legal environment in a country, and on proxies for the degree of information asymmetry between institutional investors and PE fund managers.

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Notes

  1. Accounting conservatism can be further categorized into unconditional and conditional conservatism (Beaver & Ryan, 2005). Unconditional conservatism refers to predetermined aspects of the accounting process leading to an understatement of the book value of net assets. Conditional conservatism refers to writing down the book value of assets under adverse circumstances, but not writing it up when there are favorable circumstances. This latter asymmetry is picked up in some of the private firm accounting indexes developed by Burgstahler et al. (2006), Table 2. We use different indexes to check for robustness. Also, all of our multivariate tests account for market conditions.

  2. We express the legal and accounting indexes in logs, with the exception of the Earnings Aggressiveness Index. The reason is that the values in this index are small fractions that are typically negative (see Bhattacharya et al., 2003, Table 2). We considered converting the earnings aggressiveness index into logs as well, using arbitrary rescaling to make a log transformation possible. The estimates in logs (available on request) yield similar results without qualitative differences in interpretation of any of the results.

  3. The 2007 reporting guidelines for the EVCA (see, e.g., http://www.evca.com; and http://www.evca.eu/uploadedFiles/Home/Toolbox/Industry_Standards/evca_reporting_guidelines_2009.pdf), for example, recommend reporting at cost for seed-stage investments.

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Acknowledgements

We thank the Editor, Professor Lee Radebaugh, three anonymous referees, and the workshop and conference participants at the Economic Society of Australia Annual Conference (2004), European Business School (2004), European Economic Association Annual Conference (2004), European Finance Association Annual Conference (2004), European Financial Management Association Annual Conference (2006), Goethe-Universität Frankfurt/Main (2004), Università di Bologna Almaweb Graduate School of Business (2004), Università di Bologna Forli School of Business (2004), Università di Trento Department of Legal Sciences and Faculty of Economics (2004), University of Cambridge Judge Institute of Management (2004), University of New South Wales School of Banking and Finance (2004), University of Texas Dallas (2007), York University (2007), National University of Singapore (2007), Bandeis University (2007), University of Seattle (2007), and the Vienna Symposium on Asset Management (2006). We are grateful to CEPRES (Center of Private Equity Research, Frankfurt), especially Daniel Schmidt, and the Center for Financial Studies (Frankfurt) for their generous funding and data. We also thank Sandra Sizer for her editing. This paper was awarded the Best Paper prize from the Canadian Institute of Chartered Business Valuators (CICBV) in 2009, and will be reprinted in the CICBV Journal of Business Valuation.

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  1. Schulich School of Business, York University, Toronto, Canada

    Douglas Cumming

  2. Center for Financial Studies, Goethe-Universität Frankfurt/Main, Frankfurt, Germany

    Uwe Walz

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Accepted by Lee Radebaugh, Area Editor, 31 March 2009. This paper has been with the authors for three revisions.

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Cumming, D., Walz, U. Private equity returns and disclosure around the world. J Int Bus Stud 41, 727–754 (2010). https://doi.org/10.1057/jibs.2009.62

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