The Private Equity Premium Puzzle

Abstract

We document that investment in private equity is extremely concentrated. Yet despite the very poor diversification of entrepreneurs' portfolios, we find that the returns to private equity are surprisingly low. Given the large premium required by investors in public equity, it is puzzling why households willingly invest substantial amounts in a single privately held firm with a far worse risk-return tradeoff. We examine various explanations and conclude that private nonpecuniary benefits of control must be large and/or entrepreneurs must greatly overestimate their probability of success in order to explain the observed concentration of wealth in private equity.