The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?

Abstract

Investment in private equity is extremelyconcentrated.Even though private equity returns are generally no higherthan the market return on all publicly traded equity, entrepreneurialhouseholds invest more than 70 percent of their private holdings in a singleprivate company in which they have an active managementinterest.Considering that the returns to private equity investment aretoo low given their risk, it is hard to understand why households continue tohold 75 percent of all private equity. Data from the 1989, 1992, 1995, and 1998 Survey of Consumer Finances, theFlow of Funds Accounts (1952-1999), and the National Income and ProductAccounts (1952-1999) suggest that the diversified portfolio of public equityoffers a far more attractive risk-return tradeoff than that achieved by mostentrepreneurs.There are several possible explanations for entrepreneurs'insistence upon concentrating their investments in private equity.Theseinclude high entrepreneur risk tolerance, large additional pecuniary benefits,non-pecuniary benefits (such as the autonomy of self-employment), a preferencefor skewness, and misperceived risk.(SAA)

Keywords: Survey of Consumer Finances, Flow of Funds Accounts, National Income & Product Accounts (U.S. Dept of Commerce), Equity financing, Risk orientation, Return on investment, Venture capital