Are private equity investors fooled by IRR?
56 Pages Posted: 1 Jun 2018 Last revised: 24 Apr 2021
Date Written: April 21, 2021
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: Suggested Citation