GERMAN ECONOMIC ASSOCIATION OF BUSINESS ADMINISTRATION – GEABA 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 about the economic consequences of private equity transactions. For this purpose, we separately consider six major characteristics that typically distinguish private equity investors from standard investors. Applying a sim-ple model framework, we compare both the maximum acquisition prices of private equity and standard investors for the takeover of a target firm as well as the subsequent optimal investment volumes. This analysis intends to reveal reasons for an inefficient behavior in the sense that private equity in-vestors acquire a company even though afterwards they will invest less than standard investors would do. We find that most of the usually offered argu-ments against private equity transactions, such as a higher target return, a short-term investment perspective, a lower risk aversion or operational im-provements cannot explain an inefficient behavior by private equity firms. In contrast, a high amount of leverage and informational advantages of private equity firms can result in inefficient outcomes