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Posted by Tim Jenkinson (University of Oxford), Hyeik Kim (The Ohio State University), and Michael Weisbach (The Ohio State University), on Friday, January 14, 2022

Editor’s Note: Tim Jenkinson is Professor of Finance at the University of Oxford Said Business School; Hyeik Kim is a Ph.D Candidate in Finance at The Ohio State University; and Michael Weisbach is Professor and Ralph W. Kurtz Chair in Finance at The Ohio State University. This post is based on their recent paper.

This paper provides an introduction to buyouts and the academic literature about them. Buyouts are initiated by “buyout funds”, which are limited partnerships raised from mostly institutional investors. Buyout funds have grown substantially and currently raise more than $400 billion annually in capital commitments. The funds earn returns for their investors by improving the operations of the firms they acquire and exiting them for a profit.

Intellectually, the buyout sector provides a plethora of questions to study. There are theoretical questions: How should funds be set up and managers compensated? To what extent does private contracting allow for more efficient resource allocations than a reliance on public markets? There are questions related to portfolio theory and capital markets: Private equity is a huge part of most institutional portfolios, how much capital should be allocated to this asset class, and how should it be split between various subsectors (buyouts, VC, real estate, etc)? How does one go about measuring the risk and return of a fund that makes only around 10 investments, many of which have only one cash outflow and one cash inflow over a 12 to 15 year period? To what extent do LPs and/or GPs have measurable skills? Corporate finance questions abound: How much value is created by the highly leveraged financial structure of most buyouts? What do GPs do to their portfolio firms to increase their values? Do they transfer wealth from other parties (workers, governments), or do they improve the efficiencies of operations? And perhaps the most important questions concern management and leadership, since at the end of the day, most of the increases in the value of the portfolio firms are likely to come from better managerial decisions. How do private equity funds decide on the managerial teams of their portfolio firms? What do they do to motivate and monitor these teams?

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