Publications
Publications
- 2014
Private Equity's Diversification Illusion: Economic Comovement and Fair Value Reporting
By: Kyle Travis Welch
Abstract
This study examines how accounting has informed private equity diversification claims and demand for private equity investments. Despite research showing private equity lacks portfolio diversification benefits, those marketing private equity assets continue to emphasize its diversification value, and demand for private equity investments has surged. Exploiting the change in international accounting, I show that returns provided by private equity firms understate the economic comovement between private equity and market returns, creating a diversification illusion. I find that private equity funds that adopted redefined fair value accounting reported returns with increased market beta and correlations. Additionally, I find that abnormal returns to private equity firms disappear after adopting fair value standards. In contrast to findings from public market research showing improved disclosure reduces the cost of capital, private equity firms that implement fair value standards encounter increased costs in accessing capital. This result is consistent with fair value reporting informing diversification benefits, improving resource allocation and mitigating agency concerns.
Keywords
Fair Value; Access To Capital; IAS 39; FAS No. 157; FASB; IASB; ASC 820; Covariance Risk; Accounting Beta; Accounting; Private Sector; Valuation; Corporate Finance; Asset Management; Cost of Capital; Private Equity; Accounting Industry; Financial Services Industry; Europe; North and Central America
Citation
Welch, Kyle Travis. "Private Equity's Diversification Illusion: Economic Comovement and Fair Value Reporting." Working Paper, January 2014.