Private equity firms have strong financial incentives to increase fund and deal sizes. This has clearly occurred over the last 20 years. As funds get larger it is harder to maintain relative performance, as the distribution of returns for larger deals becomes less skewed – with far fewer home-runs. On the other hand, larger funds have lower downside risk in terms of relative returns. Following the approach of Berk and van Binsbergen (2015), we contrast relative performance of a PE firm with their ability to generate increased absolute value as they increase fund size. One way to manage the size-performance trade-off is to allocate more capital to those individuals in the investment team with the most skill. We find evidence of such skill at the individual manager level, and that successful PE firms grow GVA in part by backing their winners with more capital to deploy. In this way, PE organizations can avoid sowing the seeds of their own decline: with initial strong performance leading to capital inflows and performance deterioration.
*Co-authored with R. Braun and N. Dorum (TUM)