Are private equity investors fooled by IRR?

56 Pages Posted: 1 Jun 2018 Last revised: 24 Apr 2021

See all articles by Stephannie Larocque

Stephannie Larocque

University of Notre Dame - Mendoza College of Business

Sophie Shive

University of Notre Dame - Department of Finance

Jennifer Sustersic Stevens

Ohio University

Date Written: April 21, 2021

Abstract

Private equity firms have discretion over the timing of their funds' capital calls and distributions, making the popular internal rate of return (IRR) an incomplete measure of private equity fund performance. Do investors avoid the textbook pitfalls of IRR when cash flow timing is partly endogenous? In our comprehensive sample of 6,945 funds, more than half of the funds' IRR is attributable to timing, with substantial variation. The timing component persists across a private equity firm's funds and negatively predicts future performance, but facilitates fundraising. Despite this predictability, we find little evidence that sophisticated investors avoid funds with IRRs
most affected by timing.

Keywords: Private equity, Returns, IRR, Cash-on-cash multiple

JEL Classification: G11, G23, G24

Suggested Citation

Larocque, Stephannie A. and Shive, Sophie and Sustersic Stevens, Jennifer, Are private equity investors fooled by IRR? (April 21, 2021). Available at SSRN: https://ssrn.com/abstract=3188867 or http://dx.doi.org/10.2139/ssrn.3188867

Stephannie A. Larocque

University of Notre Dame - Mendoza College of Business ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Sophie Shive (Contact Author)

University of Notre Dame - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

Jennifer Sustersic Stevens

Ohio University ( email )

College of Business Administration
526 Copeland Hall
Athens, OH 45701
United States

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