Size, Returns, and Value Added: Do Private Equity Firms Allocate Capital According To Manager Skill?

Abstract

Private equity (PE) organizations have strong incentives to increase fund and deal sizes. We show, on average, that larger deals produce lower returns, with lower risk, but produce higher gross value added in dollar terms. Employing a unique manager-deal matched data set we find performance persistence at the individual manager-level and that more capital is allocated to skilled managers in the investment team. Since investors cannot reallocate capital easily and encounter information frictions in private markets, PE organizations have an important role to play in managing the interplay of skill and scalability to maintain relative returns and value added.

Keywords: Private equity, performance persistence, value added, skill, scale

JEL Classification: G23, G24