The Asymmetric Prospects of Maximal and Minimal Extremes: Evidence from Capital Raising in the U.S. Private Equity Market

Abstract

Past performance is considered one of the most salient, reliable indicators of future performance. For this reason, when considering making investments, investors typically focus on opportunities that have, on average, shown high net returns in the past. In many markets where there is extreme uncertainty about future returns, investors may direct their attention not at straightforward financial metrics such as past net returns, but rather at performance extremes. We posit that in markets with uncertainty about future performance and with reward structures for which payoffs increase with volatility, investors may direct their attention to maximum extremes, where potential gains loom larger than losses. In these cases, maximum extremes enable firms to achieve positive differentiation and attract capital for future funds. We test our theory using data from the universe of private equity firms raising capital for new venture capital (VC) and leveraged buyout (LBO) funds in the United States from 1999-2017, and demonstrate that advantages in fundraising among firms arose from asymmetric effects of maximum and minimum extremes, whereby peak performance (i.e., gains) improved a firm’s likelihood of raising capital by more than mediocre performance (i.e., losses) hurt these prospects. Consistent with our theory, we find that these effects were more salient for firms raising funds with more considerable uncertainty (i.e., VC vs. LBO funds) and investors embracing higher risk (i.e., high-beta (beta>1) vs. low-beta strategies). We discuss the implications of our findings for decision making under uncertainty and advantages in capital raising.

Keywords: Decision Making; Attributions; Venture Capital/Private Equity; Performance

JEL Classification: G41; G11; G23; L26; M13