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Working Papers

Private Equity and Financial Fragility during the Crisis with Josh Lerner and Filippo Mezzanotti

Revise and Resubmit at Review of Financial Studies 

Does private equity (PE) contribute to financial fragility during economic crises? Academics and regulators have worried that the proliferation of poorly structured transactions during booms may increase the vulnerability of the economy to downturns. During the 2008 financial crisis, we find PE-backed companies decreased investments less than their peers, while experiencing greater equity and debt inflows. The effects are stronger among financially constrained companies and those whose PE investors had more resources at the onset of the crisis. PE-backed companies consequentially experienced higher asset growth and increased market share during the crisis. In a large-scale survey, we find that private equity firms were active investors during the crisis, spending more time with their portfolio companies to address operational and financial considerations.

Does Economic Insecurity Affect Employee Innovation? with Timothy McQuade and Richard Townsend

Do household wealth shocks affect employee output? We examine this question through the lens of technological innovation, by comparing employees that worked at the same firm and lived in the same metropolitan area, but experienced different housing wealth declines during the 2008 crisis. Following a housing wealth shock, employees are less likely to successfully pursue innovative projects, particularly ones that are high impact, exploratory, or complex in nature. The effects are more pronounced among employees with fewer outside labor market opportunities, and among employees who had little equity in their house before the crisis. In contrast, run-ups in housing prices before the crisis did not affect employee innovation. The results also highlight a “bottom-up” view of innovation, wherein lower-level employees are important determinants of firm-level innovation.

Bankruptcy Spillovers with Emanuele Colonnelli, Benjamin Iverson and Xavier Giroud

Revise and Resubmit at Journal of Financial Economics 

How do different bankruptcy approaches affect the local economy? Using U.S. Census micro-data, we explore the spillover effects of reorganization and liquidation on geographically proximate firms. We exploit the random assignment of bankruptcy judges as a source of exogenous variation in the probability of liquidation. We find that employment declines substantially in the immediate neighborhood of the liquidated establishments, relative to reorganized establishments. The spillover effects are highly localized and concentrate in non-tradable and service sectors, consistent with a reduction in local consumer traffic and a decline in knowledge spillovers between firms. The evidence highlights the externalities that bankruptcy design can impose on non-bankrupt firms. 


Asset Allocation in BankruptcyAppendix  with Emanuele Colonnelli and Benjamin Iverson, Journal of Finance, forthcoming  

This paper investigates the consequences of liquidation and reorganization on the allocation and subsequent utilization of assets in bankruptcy. Using the random assignment of judges to bankruptcy cases as a natural experiment that forces some firms into liquidation, we find that the long-run utilization of assets of liquidated firms is lower relative to assets of reorganized firms. These effects are concentrated in thin markets with few potential users, and in areas with low access to finance. The results highlight the importance of local search frictions and financial frictions in affecting the allocation of assets in bankruptcy.

Attracting Early Stage Investors: Evidence from a Randomized Field ExperimentAppendix with Arthur Kortweg and Kevin Laws, Journal of Finance lead article (2017), 72(2): 509-538.

Which start-up characteristics are most important to investors in early-stage firms? This paper uses a randomized field experiment involving 4,500 active, early stage investors. The experiment is implemented by AngelList, an online platform that matches investors with start-ups seeking capital. The experiment randomizes investors’ information sets on start-up characteristics through the use of nearly 17,000 emails. The average investor responds strongly to information about the founding team, but not to information about either firm traction or existing lead investors. This is in contrast to the least experienced investors, who respond to all categories of information. Our results suggest that information about human assets is causally important for the funding of early-stage firms.

The Operational Consequences of Private Equity Buyouts: Evidence from the Restaurant Industry with Albert Sheen, Review of Financial Studies (2016), 29(9): 2387-2418. 

How do private equity firms affect their portfolio companies? We document operational changes in restaurant chain buyouts between 2002 and 2012 using comprehensive health inspection records in Florida. Store-level operational practices improve after private equity buyout, as restaurants become cleaner, safer, and better maintained. Supporting a causal interpretation, this effect is stronger in chain-owned stores than in franchised locations -- “twin” restaurants over which private equity owners have limited control.  Private equity targets also slightly reduce employee headcount, and lower menu prices. These changes to store-level operations require monitoring, training, and better alignment of worker incentives, suggesting private equity firms improve management practices throughout the organization.

The Impact of Venture Capital MonitoringAppendix with Xavier Giroud and Richard Townsend, Journal of Finance (2016), 71(4): 1591-1622.  

We show that venture capitalists' (VCs) on-site involvement with their portfolio companies leads to an increase in both innovation and the likelihood of a successful exit. We rule out selection effects by exploiting an exogenous source of variation in VC involvement: the introduction of new airline routes that reduce VCs' travel times to their existing portfolio companies. We confirm the importance of this channel by conducting a large-scale survey of VCs, of whom almost 90% indicate that direct flights increase their interaction with their portfolio companies and management, and help them better understand companies' activities.

Private Equity and Industry Performance with Josh Lerner, Morten Sørensen, and Per Strömberg, Management Science (2016), 63(4): 1198-1213.

The growth of the private equity industry has spurred concerns about its impact on the economy. This analysis looks across nations and industries to assess the impact of private equity on industry performance. We find that industries where private equity funds invest grow more quickly in terms of total production and employment and appear less exposed to aggregate shocks. Our robustness tests provide some evidence that is consistent with our effects being driven by our preferred channel.

Does Going Public Affect Innovation?Appendix Journal of Finance (2015), 70(4): 1365-1403.
Winner of the Brattle Prize (First Prize) for Best Paper published in the Journal of Finance, 2015.

This paper investigates the effects of going public on innovation by comparing the innovation activity of firms that go public with firms that withdraw their initial public offering (IPO) filing and remain private. NASDAQ fluctuations during the book-building phase are used as an instrument for IPO completion. Using patent-based metrics, I find that the quality of internal innovation declines following the IPO, and firms experience both an exodus of skilled inventors and a decline in the productivity of the remaining inventors. However, public firms attract new human capital and acquire external innovation. The analysis reveals that going public changes firms' strategies in pursuing innovation.

The Investment Strategies of Sovereign Wealth Funds with Josh Lerner, and Antoinette Schoar,  Journal of Economic Perspectives (2013), 27(2): 219-238.

Sovereign wealth funds have emerged as major investors in corporate and real resources worldwide. After an overview of their magnitude, we consider the institutional arrangements under which many of the sovereign wealth funds operate. We focus on a specific set of agency problems that is of first-order importance for these funds: that is, the direct involvement of political leaders in the management process. We show that sovereign wealth funds with greater involvement of political leaders in fund management are associated with investment strategies that seem to favor short-term economic policy goals in their respective countries at the expense of longer-term maximization of returns. Sovereign wealth funds face several other issues, like how best to cope with demands for transparency, which can allow others to copy their investment strategies, and how to address the problems that arise with sheer size, like the difficulties of scaling up investment strategies that only work with a smaller value of assets under investment. In the conclusion, we discuss how various approaches cultivated by effective institutional investors worldwide -- from investing in the best people to pioneering new asset classes to compartmentalizing investment activities -- may provide clues as to how sovereign wealth funds might address these issues.

Contracting with Heterogeneous Externalities with Eyal Winter, American Economic Journal: Microeconomics (2012) 4(2): 50-67.

We model situations in which a principal offers contracts to a group of agents to participate in a project. Agents' benefits from participation depend on the identity of other participating agents. We assume heterogeneous externalities and characterize the optimal contracting scheme. We show that the optimal contracts' payoff relies on a ranking, which arise from a tournament among the agents. The optimal ranking cannot be achieved by a simple measure of popularity. Using the structure of the optimal contracts, we derive results on the principal's revenue extraction and the role of the level of externalities' asymmetry.