Decreasing Returns or Reversion to the Mean? The Case of Private Equity Fund Growth
53 Pages Posted: 31 Dec 2019
Date Written: December 30, 2019
When a private equity firm raises a larger fund, performance tends to decline. This pattern is usually interpreted as evidence of decreasing returns. I propose a more innocuous explanation: high-growth private equity firms were on average lucky in the past and therefore are expected to experience reversion to the mean. Controlling for this expectation, the effect of fund growth on performance is 80% to 90% smaller and statistically insignificant. The silver lining is that, historically, fund managers have been able to keep decreasing returns at bay. Additional analysis highlights important differences between buyout funds and venture capital funds.
Keywords: Private Equity, Buyout, Venture Capital, Returns to Scale, Fund Size, Skill, Luck
JEL Classification: G11, G23, G24
Suggested Citation: Suggested Citation