Desperate Capital Breeds Productivity Loss: Evidence from Public Pension Investments in Private Equity

Abstract

I study investment allocations of U.S. public pensions in private equity, and trace their investments to the ultimate micro assets -- the target firms which private equity funds invest in, using a novel micro-data on investments in private equity funds and deals, combined with confidential Census data. I show that the most underfunded public pensions match with the smallest private equity funds, and receive lower total returns relative to the least underfunded pensions. Target firms predominantly financed by the most underfunded public pensions experience a -5.2% annual change in labor productivity, and firms financed by other investors experience a +5.2% annual change. Consistent with matching between public pensions and private equity funds, I find that target firms supported by smallest funds face productivity decreases. I introduce a novel instrument of public unionization rates to establish support for underfunded positions causing selection into smaller funds. The paper discusses reasons for the existence of matching.

Keywords: public pensions, returns, productivity, private equity

JEL Classification: H55, J24, G1