Are Private Equity Investors Boon or Bane for an Economy?–A Theoretical Analysis


  • We are very grateful to an anonymous referee for many helpful comments and to the editor John Doukas, for very useful suggestions. Moreover, the paper has benefitted from comments by Kelly Carter, Werner Neus, Paul Schure and participants of the VHB conference 2009 in Nürnberg, the GEABA conference 2009 in Vallendar, the annual meeting of the Eastern Finance Association 2010 in Miami, and the annual meeting of the Midwest Finance Association 2010 in Las Vegas.


In this paper, we provide a theoretical foundation for the controversial debate on the investment behaviour of private equity investors. We separately consider six major characteristics that typically distinguish private equity investors from standard investors. Applying a simple model framework, we compare both the maximum acquisition prices paid by private equity and standard investors for the takeover of a target firm, as well as the subsequent optimal investment volumes. This analysis intends to uncover why private equity investors do (or do not) acquire a company even though they later invest less than standard investors would. We find that most of the usual arguments against private equity transactions, such as higher target return, short-term investment perspective, lower risk aversion, and operational improvements, cannot explain lower investment volume following a successful takeover by private equity firms, in contrast to other arguments, such as high level of leverage and informational advantages.