Private Equity Performance In China,Investment Organization And Its Economic Consequence

The "Decision Regarding the Reform of Science and Technology System" issued by the Central Committee of the Communist Party of China proposed the concept of venture capital for the first time in 1985.By 2016,private equity(PE)institutions in China numbered 2,045,with total assets under management(AUM)to GDP ratio at 1.11%.PE industry in China has made headway amidst twists and turns over the last thirty years,becoming popular among investors.As an important part of the multi-level capital market,PE market plays an important role in supporting innovation and entrepreneurship,particularly in the context of deepening the reform of the multi-level capital market by the government.The rapid development of PE industry makes it important and urgent to study the basic issue of PE fund performance characteristics.Then,what are the characteristics of the PE funds' performance in China? Especially,as syndicated investment becomes increasingly popular,how does the investment organization of syndication between PE funds impact investment performance? Furthermore,does the syndication between PE institutions and public firms in setting up buyout funds in the mode of“public firm + PE” realize its purpose to serve the listed firms' M&A strategies?With the growing size of AUM in the PE industry and its increasing importance in the national economy,in-depth research on these issues is of critical significance to PE investors,fund managers and regulatory authorities.A large body of literature has examined the fund performance characteristics and syndication investment strategies in developed markets(Wright and Lockett,2003;Hochberg et al.,2007;Gompers et al.,2016;Kaplan and Schoar,2005;Harris et al.,2014b).However,relevant research on emerging markets is limited.In light of this,this paper studies the above issues using PE funds in China,which is the biggest emerging market,as the sample,hoping that we can deepen our understanding of the PE industry in emerging markets.The main scope of research and conclusions drawn by this paper are as follows:(1)We examine the characteristics of PE fund performance in China.We combine PE exit events recorded by Zero2 IPO with those recorded by Wind Financial Terminal(WIND)to construct the most comprehensive exit records currently available.We calculate fund level IRR based on completed investments of each fund and further create market index adjusted return,making us the first to employ a large sample with continuous return variables that study the performance of PE funds in China.The mean(median)fund IRR,net of fees,is 99.6%(12.4%).The concave relation between fund size and fund performance is statistically insignificant or only marginally significant.Competition reduces fund performance:returns are lower when there are many competitors entering the industry in the same year.Fund IRRs are not related to overall market conditions around the time when the fund is raised.The formation of a new fund and size of the new fund depend mainly on earlier fund returns for experienced partnerships,and on public market conditions for less experienced ones.The common fee structure of PE fund in China consists of a 2% management fee of capital committed throughout the entire life of a fund plus a 20% carried interest.With this fee structure,managers would form funds as large as they can to earn more management fees.There is no evidence of return persistence across funds managed by the same GP,neither for PE funds nor for VC funds.In addition,our results are robust even after controlling for sample selection bias and taking fund performance estimation bias into account.(2)This paper investigates the impact of PE funds syndication as a form of investment organization on investment performance.Taking syndication investment defined in the narrow sense,we investigate factors that affect the syndication decision of private funds in the target firms' certain round of financing,the influence of syndication on investment performance and the way through which it affects the performance.Because syndicated investments usually choose firms in the expansion or maturity stage with greater funding requirements,but the limited partnership agreement of PE funds often sets a cap on the share of investment amount that the managers can invest in a single target,so it is possible that capital constraint is the main factor that affect syndication decision.Our regression results confirm this conjecture: in China,both the relative and absolute capital constraints have significant positive effects on PE funds' syndication decision.At the same time,we find that the diversification of portfolio and reducing the challenges posed by complex projects are not the main reasons for syndication of private funds in China.The target companies' performance of syndicated investments is significantly higher than that of independent investments in terms of both the probability of IPO and the chance of survival to the next financing round,and the relation between the number of funds in the syndication and the target firm performance is concave.Further,we use headquarter location of funds as an instrumental variable to do the seemingly unrelated bivariate Probit regression to investigate how syndication affects investment performance(Krishnan et al.,2011;Das et al.,2011;Guo and Jiang,2013).The results indicate that project selection is the main explanation for the outperformance when syndicate,while value-added hypothesis does not hold in China.Instead of providing additional value-adding service,the non-lead syndicate funds become “free riders” after capital contribution and the coordination cost between partner funds can even compromise investment performance.(3)We study the economic consequences of the unique syndication strategy in China: that is,PE institutions and listed companies syndicate by jointly setting up buyout funds in the mode of "public firm + PE" to serve the M&A strategies of listed companies,realizing the integration of industrial capital and financial capital.Based on a hand-collected sample of formation and investing data of buyout funds in China from 2007 to 2015,this paper investigates the influence of buyout funds on the economic consequence of mergers and acquisitions of Chinese firms.We find that public firms tend to cooperate with PE firms that are larger in size and with more investing and exiting experience to set up buyout funds.Compared to direct M&As(i.e.,direct acquisition of target companies by acquiring firms)and indirect M&As(i.e.,acquiring firms purchase target shares from intermediaries such as PE funds),buyout fund initiated M&As experience significant lower acquisition premium and shorter time span.For instance,the premium paid in buyout fund initiated M&As is reduced by 73.7% relative to the sample median.The transaction time to complete the deal also decreases by 69.8% relative to the sample average.With regard to postacquisition performance,although there is no significant difference in the average cumulative abnormal return(CAR)of the participating public firms shortly after the M&A transactions,the CAR of the acquiring firms in the 250 trading days following M&A transactions is significantly higher than that of the other two types of M&As.Meanwhile,buyout fund initiated M&As do not experience the same decline in postacquisition long-term market performance that is commonly seen in other M&As.Our results indicate that the appropriate organizational form in the cooperation between listed firms and PE institutions can make up for the disadvantages of other types of M&As,thus improving investment efficiency and increasing firm value.Possible creative points of this thesis include:(1)This paper constructs a more detailed and complete sample based on the data collected by hand.In addition to public information,databases also obtain relevant information from fund management companies and intermediaries such as law firms in the form of questionnaire,so different databases are complementary to a certain extent.Hence,we complement the Zero2 IPO sample by cross-checking and adding non-overlapping PE investments from WIND when studying PE performance,and construct the most complete fund exit sample with the available data,which provide a good data foundation for the follow-up research.Since WIND database does not provide bulk download of the formation and investment data of buyout fund,with relevant data scattered across specific events,and CSMAR database does not disclose the M&A transaction type,we have to collect relevant information and distinguish the type of each M&A transaction manually.With these hand-collected data we study the economic consequences of setting up buyout funds by listed firms and PE institutions for the first time.(2)We construct fund level continuous performance indicators for the first time to study PE performance.We break through the limitation that continuous return variables are constrained to investment project level in previous studies when studying performance characteristics in PE industry of China,which is the largest emerging market.Our results to an extent contribute to the understanding of the PE performance of other emerging markets.In addition,to control for the left censoring in the logarithm of capital committed to a follow-on fund,we estimate a Tobit regression to see how market circumstances and track record affect capital inflows.(3)As for syndication between PE funds,existing literature mainly focuses on the broadly-defined syndication.From the perspective of funds syndication investment in the narrow sense,this paper studies factors influencing syndication decisions of PE funds and the effect of syndication on investment performance.More importantly,using instrumental variable to control for the endogenous matching between high quality target firms and syndicated funds,we discuss for the first time through which way syndication affects investment performance in China.To discover the channel through which syndication of PE funds affects investment performance we use seemingly unrelated bivariate Probit model.If project selection hypothesis holds in China,then we need to control for endogeneity in syndication.Using fund headquarter location as an instrumental variable,we are able to distinguish the project selection effect and the value-added effect.(4)Buyout funds set up in the mode of "public firm + PE" as an investment organization that PE institutions syndicate with listed companies are newly emerged in China.We study the implications of such syndication on M&A premium,deal speed and post-acquisition performance to determine if buyout funds do serve the investment strategy of public firms.The study thus enhances our understanding of both the ex-ante economic rationale and ex-post consequences of this new investment organization form.Referring to Jiang et al.(2010),we use the differences-in-differences regression specifications to study the long run performance of the three types of transaction mode.This model not only provides the mean differences(Dif)in the long run performance between firms that have undertaken M&A transactions and firms in the control group,but also displays the differences in differences(DID)before and after the transaction and between groups,resulting in a more comprehensive understanding of buyout fund initiated M&As.