The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?

Abstract

We document the return to investing in U.S. nonpublicly traded equity. Entrepreneurial investment is extremely concentrated, yet despite its poor diversification, we find that the returns to private equity are no higher than the returns to public equity. Given the large public equity premium, it is puzzling why households willingly invest substantial amounts in a single privately held firm with a seemingly far worse risk-return trade-off. We briefly discuss how large nonpecuniary benefits, a preference for skewness, or overestimates of the probability of survival could potentially explain investment in private equity despite these findings. (JEL G11, G12, M13)

Risk Attitudes and Private Business Equity

“…Moskowitz and Vissing-Jorgensen (2002) report that entrepreneurial households in the United States invest on average as much as 41.1 percent of their wealth in private firm equity. Here entrepreneurial households are defined as households with positive private business equity holdings and positive net worth.…”

“…The study by Moskowitz and Vissing-Jorgensen (2002), who conclude that the returns to private equity are no higher than those to public equity, represents the most comprehensive published analysis to date. Table 2 summarizes some of their estimates.…”

“…It should be noted that the empirical results of Moskowitz and Vissing-Jorgensen (2002) about the low monetary returns to private business equity have not remained unchallenged. In a working paper, Kartashova (2011) …”

“…This observation may be called a private equity premium puzzle (Moskowitz and Vissing-Jorgensen, 2002). …”

“…Yet despite the progress made, a fundamental question remains: Why do people engage in entrepreneurship and commit large parts of their personal wealth to their business, despite the fact that the monetary risk-return trade-off, on average, looks rather unattractive in comparison to alternative wage employment (Hamilton, 2000) and investment in a public equity portfolio (Moskowitz and Vissing-Jorgensen, 2002)? This chapter attempts to connect several streams of literature to shed some light on possible research avenues forward.…”