[The performance of private equity funds as reported by industry associations and previous research is overstated. A large part of performance is driven by inflated accounting valuation of ongoing investments and we find a bias toward better performing funds in the data. We find an average net-of-fees fund performance of 3% per year below that of the S&P 500. Adjusting for risk brings the underperformance to 6% per year. We estimate fees to be 6% per year. We discuss several misleading aspects of performance reporting and some side benefits as a first step toward an explanation]

The performance of private equity funds as reported by industry associations and previous research is overstated. A large part of performance is driven by inflated accounting valuation of ongoing investments and we find a bias toward better performing funds in the data. We find an average net-of-fees fund performance of 3% per year below that of the S&P 500. Adjusting for risk brings the underperformance to 6% per year. We estimate fees to be 6% per year. We discuss several misleading aspects of performance reporting and some side benefits as a first step toward an explanation.

We propose a security design model in which a potential acquirer approaches a firm with a value-add plan. The target has a single owner, who possesses private information: he alone knows whether his firm is compatible with the plan. The owner agrees that the acquirer will add value but believes that the value-add will not be as much as what the acquirer expects. Although the acquirer can choose any monotone limited liability security to offer along with cash, we show that, under general conditions, any security that is employed always takes the form of nonrecourse debt provided by the seller.