Liquidity Shocks and Private Equity Investment

Abstract

I demonstrate that investor composition influences private equity (PE) investment dynamics due to investors' heterogeneous costs of financing illiquid investments during liquidity shocks. The variation stems from differences in their liability structure. During large natural disasters, PE funds with more committed capital from property and casualty insurers invest less than other near-identical funds. This investment distortion reduces the productivity of private companies. However, the shock transmission is attenuated ex-post when funds can adjust their investor base more easily or enforce drawdowns more effectively. To mitigate liquidity shocks ex-ante, funds exposed to shock-prone investors accelerate drawdowns, leading to inefficient investment. Overall, the growing interconnectedness between PE and other financial markets could create systemic risk and have capital allocation implications.

Keywords: Nonbanks, Institutional Investors, Insurers, Private Equity, Liquidity Shocks, Capital Allocation

JEL Classification: E22, G11, G22, G23, G24