Comparing Capital Allocation Efficiency in Public and Private Equity Markets

Abstract

Investors increasingly allocate capital outside of public equity markets and through private equity investments. We evaluate capital allocation efficiency in public and private markets by comparing the marginal product of capital in firms that receive equity in each market. Public markets allocate capital substantially more efficiently than private markets. A dollar of equity allocated through public markets generates at least three times more sales than a dollar allocated to comparable firms in private markets. The difference in allocation efficiency is persistent over time and across industries. We use cross-sectional tests and quasi-natural experiments to show that the allocation efficiency gap is driven by improved information efficiency and governance mechanisms in public markets. Our study highlights the role of stock markets in improving capital allocation in the economy, and a potential implication of shrinking public markets and the growth of private equity.

Keywords: Capital allocation, stock markets, private equity, venture capital, growth equity, information efficiency, governance

JEL Classification: G14, G24, G32, G34, E22