University of Texas Roundtable on LP Perspectives on the State of Private Equity

In this wide‐ranging discussion among four limited partner investors in private equity, the LPs commented on the rates of return they expect from PE, the fees they pay their general partners, and the length of their time commitments to PE investments. After noting the enormous growth in the value of assets under private management, and the reduction in public equity investment by many large institutional investors, each of the four LPs said that their institutions expected to maintain or continue to increase their proportion of portfolio investment in PE. The LP panelists were virtually unanimous in expecting PE rates of return in the 9%‐11% range, as compared to 7%‐8% for public equities. The panelists also seemed to agree that although committing to PE investments for terms longer than the traditional seven to ten years could result in higher returns and lower costs, they were reluctant to make such commitments because they valued the financial flexibility afforded by shorter holding periods. Several LPs claimed that their institutions were scrutinizing the explicit and implicit fees charged by the GPs, and the level of fees was encouraging LPs to co‐invest in deals alongside the GPs. And in response to a closing suggestion that the recent flurry of IPOs could signify the beginning of a major reversal away from private capital, another LP expressed strong doubt, noting that “the private ownership model has clearly shown superior governance, and greater ability to manage leveraged capital structures and create value than public companies over the long term.”     

Morgan Stanley Roundtable on The State of Global Private Equity

In this discussion led by Alan Jones, Morgan Stanley's head of Global Private Equity, the University of Chicago's Steve Kaplan begins by surveying 25 years of academic research on private equity. Starting with Kaplan's own Ph.D. dissertation on leveraged buyouts during the 1980s, finance academics have provided a large and growing body of studies documenting the ability of private equity firms to make “sustainable” (that is, maintained over a three‐ or four‐year period) improvements in the operating performance of their portfolio companies, whether operating abroad or in the U.S. Even more impressive, the findings of Kaplan's new study (with Tim Jenkinson of Oxford and Bob Harris of the University of Virginia) suggest that these improvements have been large enough to enable PE funds raised between 1990 and 2008 to deliver returns to their limited partners that have averaged 300 to 400 basis points higher per year than the returns to the S&P 500. And given the “persistence” of PE fund returns—the tendency of the funds of the same PE firms to show up in the top quartile of performers year after year—that Kaplan has documented in earlier work, the performance of private equity seems notably different from that of mutual funds and hedge funds, where there has been little if any consistency in the returns provided by the top performers. Following Kaplan's overview of the research, four representatives of today's leading private equity firms explore questions like the following:

• ? How do the best PE firms, after paying premiums to acquire their portfolio companies and collecting large management fees, provide such consistently high returns to their limited partners?
• ? How did PE portfolio companies perform during the last recession, when many popular business publications were predicting the death of private equity—and what, if anything, does that tell us about how private equity adds value?
• ? What can PE firms do to avoid, or at least limit the damage from, the overpricing and overleveraging that tend to occur near the end of the boom‐and‐bust cycle that appears to be a permanent feature of private equity?

As Jones notes in his opening comments, the practitioners' answers to such questions “should help investors distinguish between the alpha that the firms represented at this table have generated through active management from the ‘closet beta’ that critics say results when private equity firms simply create what amounts to a levered bet on the public equity markets.”     

University of Texas Roundtable on Recent Trends in U.S. Venture Capital

At a recent private equity conference hosted by the McCombs School of Business at the University of Texas in Austin, four venture capitalists representing the East and West Coasts provided testimony to the spread of the VC industry far beyond Silicon Valley to places like New York, London, and Berlin—as well as Austin itself. The result, in the words of one panelist, has been “a shift from Silicon Valley as the epicenter of so much innovation and growth to something more like a globally distributed network of capital, talent, and opportunity.” Along with this geographic expansion of the industry, perhaps the most notable change is the tendency of today's VCs to delay the IPOs of their portfolio companies and, by keeping them private longer, capture more of their growth in value. Whereas 20 years ago 90% or more of the value appreciation came after the IPO of a highly successful company (think about Micro‐Soft or Amazon.com ), a much larger share of the overall value creation now appears to be taking place before the IPO, thanks to the growing use of a funding vehicle known as private initial public offerings, or PIPOs. The use of PIPOs has enabled VC‐backed companies to attract large amounts of capital from large institutional investors like Fidelity—which in the past would not have invested in the company until the IPO—while retaining what the panelists view as significant advantages of private ownership and governance.     

University of Texas Roundtable on The Role of Private Equity in the Financing and Restructuring of Oil and Gas Companies

In this second of two University of Texas roundtables, four highly successful veterans of the U.S. energy industry, with considerable experience running both public and private companies, discuss recent developments in this rapidly evolving industry. Among the most remarkable—and a major focus of this discussion—is the dramatic expansion of the output and productivity of the Permian Basin of West Texas, and the role of private equity in accomplishing it. Although the Permian has been a major source of oil and gas since 1920, the combination of massive horizontal drilling and hydraulic fracturing has contributed to a tripling of production volumes from about 800,000 barrels per day to 2.5 million during the past ten years. In fact, the productivity gains are said to be so great that, even with the huge run‐up in the cost of acquiring acreage (to as high as $40,000 per acre), today's producers are projecting annual operating returns of 20% even if oil prices fail to rise above their current level of about $50 a barrel. What's more, there appears to have been a fairly clear division of labor between private and public companies in this recent development of the Permian. With most of the high‐priced acreage now being acquired by larger public companies, the primary role of private equity has been to identify and make good on opportunities to increase the productivity and value of smaller operations that can then be sold to public companies—companies that have the size and access to capital to benefit from the economies of scale produced by combining them with their other operations. Thanks to their earlier position in the value chain, investments by private equity groups have generally not only produced higher payoffs, on average, but involved larger operating and financial risks. And this difference in risk profile is reflected in a notable difference in hedging practices between public and private equity‐controlled companies. This difference was summed up as follows by a private equity partner who has also run several public oil and gas companies: To a much greater extent in private equity than in public companies, we think of our projects and companies as delivering value that is largely independent of changes in oil prices. Hedging is our way of saying we don't want to take oil price risk if we don't have to. We do not count on price increases to make our required returns. The returns come from operating the company successfully without the help of commodity prices.     

Private Equity in the U.S.: Building a New Future

Despite the recent downturn, private equity firms still have an important role to play in the global economy. At the same time, many PE firms may need to rethink their strategies. Practices that have been worked in the past may not produce acceptable returns in a future, particularly given the current constraints on financing and leverage. One source of PE's comparative advantage, as demonstrated during the recent crisis, has been the ability of the best and most experienced firms to reorganize their portfolio companies when they get into financial trouble. But in addition to their financial management skills, specialized operating expertise has become more critical to success, and those PE firms that have not acquired it are especially likely to find that past success in raising capital is no guarantee of success in the future. The authors begin by providing a brief overview of the past three decades of global private equity to identify how the market arrived at its current position. Using the findings of academic research together with case studies and interviews with PE practitioners in the U.K., the authors suggest a number of building blocks for the future that reflect the considerable success of the most reputable and experienced PE firms in increasing the value of their portfolio companies.     

Order Preferencing and Market Quality on U.S. Equity Exchanges

We present a detailed view of market quality in the presenceof preferencing arrangements. A unique dataset provides theopportunity to measure trading costs of marketable orders andfill rates and ex post costs of limit orders across tradingvenues. For market orders, we find the primary exchange providesthe lowest execution costs. However, the preferencing exchangesare no worse than, and in most cases better than, the nonpreferencingregional exchanges. For limit orders, the regionals executelimit orders more frequently than the primary market and withan ex post execution cost that is not very different from theprimary market.     

Columbia Law School Roundtable on Public Aspects of Private Equity

The mandate of the broader private equity “ecosystem” goes well beyond earning competitive returns for the limited partners and their beneficiaries. After noting that PE investing is encountering ever larger “headline” and social risks, the panelists were in complete agreement that LPs should exert greater pressure on PE sponsors to take account of and try to address negative externalities when buying and operating their portfolio companies. Bain Capital's Double Impact Fund, for example, while always looking for ways of increasing profits and reducing risk, sets out to have a positive influence on its non‐investor stakeholders, including employees. To that end, Bain develops and tracks company‐specific metrics linked to positive outcomes, and then links those metrics to management compensation. And the director of ESG programs at the International Limited Partners Association points to ILPA's programs for diversity and inclusion as a promising model.     

The Private Equity Market: An Overveiw

The private equity market is an important source of funds for start‐up firms, private middle‐market firms, firms in financial distress, and public firms seeking buyout financing. Over the past fifteen years it has been the fastest growing corporate finance market, by an order of magnitude over the public equity and public and private bond markets. Despite its dramatic growth and increased significance for corporate finance, the private equity market has received little attention. This study examines the economic foundations of the private equity market, analyzes its development and current role in corporate finance, and describes the market's institutional structure. It examines the reasons or the market's explosive growth over the past fifteen years and highlights the main characteristics of that growth. It provides data on returns to private equity investors and analyzes the major secular and cyclical influences on returns. It describes the important investors, intermediaries, issuers, and agents in the market and their interactions with each other. Drawing on data from trade journals, the study also estimates the market's size as of year‐end 1995.     

Morgan Stanley Roundtable on Private Equity and Its Import for Public Companies

The role of private equity in global capital markets appears to be expanding at an extraordinary rate. Morgan Stanley estimates that there are now some 2,700 private equity funds that either have raised, or are in the process of raising, a total of $500 billion. With this abundance of available equity capital, the willingness of private equity firms to participate in “club” deals, and the leverage that can be put on top of the equity, private equity buyers now appear able and willing to pay higher prices for assets than ever before. And thanks in part to this new purchasing power, private equity transactions reportedly account for a quarter of all global M&A activity as well as a third of the high yield and IPO markets. The stock of capital now devoted to private equity reflects the demonstrated ability of at least the most reputable buyout firms to produce consistently high rates of returns for their limited partners. Although a talent for identifying and purchasing undervalued assets may be part of the story, the ability to produce such returns on a consistent basis implies an ability to add value, to improve the performance of the operating companies they invest in and control. And in this round‐table, a small group of academics and practitioners address two main questions: How does private equity add value? And are there lessons for public companies in the success of private companies? According to the panelists, the answer to the first question appears to have changed somewhat over time. The consensus was that most of the value added by the LBO firms of the‘80s was created during the initial structuring of the deals, a process described by Steve Kaplan as “financial and governance engineering,” which includes not only aggressive use of leverage and powerful equity incentives for operating managements, but active oversight by a small, intensely interested board of directors. In the past ten years, however, these standard LBO features have been complemented by increased attention to “operational engineering,” to the point where today's buyout firms feel obligated, like classic venture capitalists, to acquire and tout their own operating expertise. In response to the second of the two questions, Michael Jensen argues that much of the approach and benefits of private equity‐particularly the adjustments of financial policies and stronger managerial incentives‐can be replicated by public companies. And although some of these benefits have already been realized, much more remains to be done. Perhaps the biggest challenge, however, is finding a way to transfer to public companies the board‐level expertise, incentives, and degree of engagement that characterize companies run by private equity investors.     

U.S. International Equity Investment

Using a comprehensive data set of all U.S. investment in foreign equities, we find that the single most important determinant of the amount of U.S. investment a foreign firm receives is whether the firm cross‐lists on a U.S. exchange. Correcting for selection biases, cross‐listing leads to a doubling (or more) in U.S. investment, an impact greater than all other factors combined. Much of this increased U.S. investment is purchased in the foreign market, implying that the cross‐listing effect reflects something more fundamental about a firm than easier acquisition of its securities. We also demonstrate that cross‐listing is an important determinant of U.S. international investment at the country level and describe easy‐to‐implement methods for including a cross‐listing variable as an endogenous control.     

The Impact of the U.S. and the Japanese Equity Markets on the Emerging Asia-Pacific Equity Markets

Using a tri-variate vector autoregression model, we study the relationships between the four Asian emerging equity markets: Hong Kong, Korea, Singapore and Taiwan, and the two largest equity markets in the world: U.S. and Japan. We find that while most of the unexpected variations in stock returns in these Asian emerging markets is explained by domestic own shocks, the impacts from the U.S. and Japan are larger in Hong Kong and Singapore than in Korea and Taiwan. This foreign effect is pronounced after the Crash of the October 1987, especially in Singapore. This revised version was published online in August 2006 with corrections to the Cover Date.     

Market Efficiency and the Returns to Simple Technical Trading Rules: New Evidence from U.S. Equity Market and Chinese Equity Markets

Numerous studies in the finance literature have investigated technical analysis to determine its validity as an investment tool. This study is an attempt to explore whether some forms of technical analysis can predict stock price movement and make excess profits based on certain trading rules in markets with different efficiency level. To avoid using arbitrarily selected 26 trading rules as did by Brock, Lakonishok and LeBaron (1992) and later by Bessembinder and Chan (1998), this paper examines predictive power and profitability of simple trading rules by expanding their universe of 26 rules to 412 rules. In order to find out the relationship between market efficiency and excess return by applying trading rules, we examine excess return over periods in U.S. markets and also compare the excess returns between U.S. market and Chinese markets. Our results found that there is no evidence at all supporting technical forecast power by these trading rules in U.S. equity index after 1975. During the 1990s break-even costs turned to be negative, –0.06%, even failing to beat a buy-holding strategyin U.S. equity market. In comparison, our results provide support for the technical strategies even in the presence of trading cost in Chinese stock markets.     

Toward a National Market System for U.S. Exchange–listed Equity Options

In its response to the 1975 Congressional mandate to implement a national market system for financial securities, the Securities and Exchange Commission (SEC) initially exempted the option market. Recent dramatic changes in the structure of the option market prompted the SEC to revisit this issue. We examine a sample of actively traded, multiply listed equity options to ask whether this market's characteristics appear consistent with the goals of producing economically efficient transactions and facilitating “best execution.” We find marked changes between June 2000, when quotes are often ignored, and January 2002, when the market more closely resembles a national market.     

美国股票回购理论的历史演变

仅用一种理论来解释股票回购的动机几乎是不可能的，因为实施股票回购公司的管理层的目的有可能是多方面的。股票回购对公司本身多方面的影响，造成了分析股票回购动机的复杂性。……     

Statement of the Financial Economists Roundtable on the International Competitiveness of U.S. Capital Markets

The Committee on Capital Markets Regulation issued an Interim Report (known as the “Paulson Report”) near the end of 2006 that concluded that the U.S. “is losing its leading competitive position as compared to stock markets and financial centers abroad.” This report was quickly followed by a study, which reached similar conclusions, that was commissioned by New York Mayor Michael Bloomberg and Senator Charles Schumer and prepared by McKinsey & Co. At its July 2007 annual meeting, the Financial Economists Roundtable (FER) — a group of senior financial economists at universities and other organizations recognized as having made significant contributions to the finance literature—discussed the issues raised by the Report and decided to publish its own report. The report makes the following four policy recommendations:

• 1 Securities class action suits —Abolish enterprise liability under rule 10b‐5 in situations arising out of security purchases and sales in the secondary trading market among outside shareholders, while retaining managerial and firm liability where the company itself or its insiders (officers and directors) transact to their own benefit. Imposing massive liability on a company that is not a party to the securities transactions and does not benefit from the fraud does not serve a deterrence function since it is the continuing shareholders of the corporation who bear the burden of what the company must pay if found guilty, either directly or indirectly through insurance premiums.
• 2 Shareholder rights—Require all corporations to obtain shareholder approval to adopt a poison pill, regardless of whether a company has a staggered board. This requirement would conform to the broad principle that the board of any company should not be able to deny its shareholders the opportunity to decide on the merits of a takeover bid, and it would help restore the market for corporate control as an effective disciplinary mechanism for poorly performing boards and managers.
• 3 Compliance costs associated with SOX §404—Adopt a statutory amendment that makes it optional for a company to adopt the §404 procedures for a management assessment and auditor attestation of the effectiveness of its internal controls, with the requirement that if the company chooses not to comply it must explain why in its financial statements. Thus, in effect, the FER effectively recommends that the market be allowed to determine the value of §404 compliance. If a company chooses not to comply, the market will assess its explanation for non‐compliance and will value the company accordingly.
• 4 Maintaining open markets—Allow both foreign and U.S. firms to choose to report in conformity with either IFRS or U.S. GAAP. The FER recognizes both IFRS and U.S. GAAP as high‐quality accounting standards that provide reasonable foundations for financial reporting for investors. Allowing both foreign and U.S. firms to adopt whichever of these standards they believe to be the most cost‐effective provides an opportunity for the market and investors themselves to sort out which reporting standard best serves their interests.

     

Global Integration in Primary Equity Markets: The Role of U.S. Banks and U.S. Investors

We examine the costs and benefits of the global integrationof initial public offering (IPO) markets associated with thediffusion of U.S. underwriting methods in the 1990s. Bookbuildingis becoming increasingly popular outside the United States andtypically costs twice as much as a fixed-price offer. However,on its own, bookbuilding only leads to lower underpricing whenconducted by U.S. banks and/or targeted at U.S. investors. Formost issuers, the gains associated with lower underpricing outweighedthe additional costs associated with hiring U.S. banks or marketingin the United States. This suggests a quality/price trade-offcontrasting with the findings of Chen and Ritter, particularlysince non-U.S. issuers raising US$20 million–US$80 millionalso typically pay a 7% spread when U.S. banks and investorsare involved.     

The Reversing Weekend Effect: Evidence from the U.S. Equity Markets

The well-known weekend effect has been reversing in Major U.S. indices from late 1980s to late 1990s. The correlation between Monday and Friday returns also exhibited a declining trend, and fluctuated around zero in the 1990s. A power ratio method is developed to measure consistently the relative contribution of Friday and Monday returns to the return of the week in each individual year. The revealed dynamics of the anomaly explains why previous researchers report different or conflicting findings. The anomaly may not be necessarily related to firm size.     

美国证券市场高科技上市公司研究

高科技的宠儿——YAHOO公司，是一个靠借款建立起来的网络公司，通过上市，一夜之间取得了令人难以置信的财富，股价最高时达到450美元。在证券市场的协助下，“知识就是财富”的内涵获得了淋漓尽致的表现，也改写了资本称霸证券市场的历史。     

U.S. Equity Investment in Emerging Stock Markets

This article examines U.S. equity flows to emerging stock marketsfrom 1978 to 1991 and draws three main conclusions. First, despitethe recent increase in U.S. equity investment in emerging stockmarkets, the U.S. portfolio remains strongly biased toward domesticequities. Second, of the fraction of the U.S. portfolio thatis allocated to foreign equity investment, the share investedin emerging stock markets is roughly proportional to the shareof the emerging stock markets in the global market capitalizationvalue. Third, the volatility of U.S. transactions in emerging-marketequities is higher than in other foreign equities. The normalizedvolatility of U.S. transactions appears to be falling over time,however, and we find no relation between the volume of U.S.transactions in foreign equity and local turnover rates or volatilityof stock returns.