Value Creation in Private Equity

Abstract

We disentangle the effects of treatment, selection, and financial engineering on investor returns in private equity deals using a narrative approach for identification. Exploiting confidential textual data contained in pre-deal investment memos and value creation plans, we show that PE firms create value for investors by selecting companies that are about to outperform (akin to stock picking) and by helping portfolio companies improve production through CAPEX and acquisitions, but not by financial engineering. Tracking the post-investment implementation of value creation plans using confidential monitoring reports, we show that successful execution increases investor returns over and above the return-boosting effects of successful stock picking.

Keywords: Private equity, value creation, treatment vs. selection, investor returns

JEL Classification: G11, G24, G30, G32, L26