Are Private Equity Investors Boon or Bane for an Economy?–A Theoretical Analysis

In this paper, we provide a theoretical foundation for the controversial debate on the investment behaviour of private equity investors. We separately consider six major characteristics that typically distinguish private equity investors from standard investors. Applying a simple model framework, we compare both the maximum acquisition prices paid by private equity and standard investors for the takeover of a target firm, as well as the subsequent optimal investment volumes. This analysis intends to uncover why private equity investors do (or do not) acquire a company even though they later invest less than standard investors would. We find that most of the usual arguments against private equity transactions, such as higher target return, short†term investment perspective, lower risk aversion, and operational improvements, cannot explain lower investment volume following a successful takeover by private equity firms, in contrast to other arguments, such as high level of leverage and informational advantages.