Private Equity Valuations and Public Equity Performance

Abstract

It is reasonable to expect that changes in private equity valuations should bear some correspondence to public equity performance, because both private assets and public assets respond to common influences such as changes in discount rates. But it is also reasonable to recognize that changes in private equity valuations should depart to some extent from public equity performance owing to differences in risk, liquidity, and cash flow expectations. These differences affect the degree of correspondence. In this paper, we explore an additional influence on private equity valuations that affects not the degree of correspondence, but rather the symmetry of the correspondence. We argue that because private equity managers are less constrained than public market participants by the forces of no-arbitrage pricing, they have greater discretion to introduce biases into their valuations. Based on an extensive sample of private equity valuations, we find persuasive evidence that private equity managers produce positively biased valuations that appear to be rationalized by information that should not be relevant.

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