Is Private Equity Investor Good or Evil?∗

Oleg Badunenko†
DIW−Berlin

Nataliya Barasinska‡
DIW−Berlin

Dorothea Schäfer§DIW−Berlin

May 11, 2009

∗ Financial support from the European Commission (7th Framework Programme, Grant Agreement

No. 217266) is gratefully acknowledged. We thank Christopher F. Baum and Doris Neuberger for helpful comments and suggestions.
† German Institute for Economic Research (DIW−Berlin), 10108, Berlin, Germany.
Phone:+49.30.89789.203. Fax: +49.30.89789.104, E-mail: obadunenko@diw.de.
‡ German Institute for Economic Research (DIW−Berlin), 10108, Berlin, Germany.
Phone:+49.30.89789.691. Fax: +49.30.89789.104, E-mail: nbarasinska@diw.de.
§ German Institute for Economic Research (DIW−Berlin), 10108, Berlin, Germany.
Phone:+49.30.89789.162. Fax: +49.30.89789.104, E-mail: dschaefer@diw.de.

Is Private Equity Investor Good or Evil?

Abstract
Abstract
The paper investigates the motives of activity (entry and exit) of Private Equity (PE)investors in European companies. Investment of a PE firm is not viewed unambiguously. First, it is claimed that PE investment is made for the sake of seeking short-term
gains by taking control and utilizing the company’s resources. Second, PE firm invests
because of prior identification of chances to add value to the company. We attempt
to resolve these two conflicting conjectures. We use the Bureau van Dijk’s Amadeus
database of very large, large and medium sized European companies. Our major results can be summarized as follows. First, PE firms are less willing to enter the firm
if it already has blocking majority and try to leave the firm if control cannot be overtaken. Second, less mature firms have lower chances to lure a PE firm to invest, but
PE exit is unaffected by firms maturity. Third, PE investor does not seem to care muchabout the management of the company, but when it leaves labor productivity betterbe bigger. Finally, on both entry and exit PE wishes large shareholder funds, yet it
initiates exit once firm’s cash melts.

Keywords: Private equity financing, leverage, corporate finance
JEL Classification: M14, G24, G34

1 Introduction
In many European countries the importance of private equity (PE thereafter) activity hasrisen in recent years. At the same time, domestic private equity/buy-out providers havecome under increased scrutiny of policy makers. For example in spring 2008 Germany
has enacted the Risk Limitation Act in hope to prevent objectionable macro economic
activities of financial investors without simultaneously impairing efficient financial andcorporate transactions. Similar activities have been initiated in other European countries.
Despite the fact that the German law concedes a trade-off between the benefits and thecosts of PE investment, the fear of the public that PE investors behave as “locusts” once
they have entered a firm is still at the center of the public debate. PE investors are often
blamed for the opportunistic behavior and PE investors are seen as seeking short-term
gains by taking control and utilizing the firm’s resources. Furthermore, the fear has itthat PE focus primarily on wealth redistribution that is detrimental for the rest of thefirm’s stake holders. The holders of the opposite view, however, see PE as a mechanismthat facilitates the development of a firm which would otherwise be constrained from
exploiting opportunities for growth, that is support the ‘welfare-improving’ argument.
The empirical evidence for these competing views of the phenomenon of private equity
is however merely missing. Investigation of the motives of PE engagement in a firm andits influence on firm’s performance is lacking (EEAG, 2006). The present paper is thefirst attempt to study the determinants of private equity activity (investment and exit)in Europe. By analyzing the determinants of PE activity at a micro-level, we intend toaddress two conflicting conjectures about the motives of PE investors: (i) investing forthe sake of pure rent-seeking and (ii) investing because of prior identification of chances
to add value to the company.
Because the comprehensive ownership and financial data are largely missing, particularly across countries, previous studies on the determinants of PE investment havefocused on mere qualitative analysis (e.g. Thompson and Wright, 1995) or have looked
only at particular aspects of the investment decision (e.g. Opler and Titman, 1993). Moreover, the analyses of activity of PE firms have been limited to the US market and listed
firms as target companies. In the latter case the significant drivers for the investment areoften indirectly redesigned by means of an event study (e.g. Achleitner et al., 2008).

2

In this paper, we examine whether PE investment is motivated by the benefits of relaxing financial constraints and incentive realignment and whether PE firm is attracted bypossibilities of wealth redistribution. We do so by comparing the previous year characteristics of firms that have received a PE shareholder with those that have not. Evidence
that PE shareholding is more common in firms with characteristics that indicate severe
financial restrictions and/or a high potential for incentive realignment would support
the hypothesis that the investment has been motivated by possibility to create rather than
redistribute wealth. In addition, evidence that firms with a relatively high potential for
redistribution are not the dominant targets of PE investors would suggest that concerns
about rent-seeking activities are overstated.
We are interested in a cross-country comparison because different features characterize the financial systems and the capital markets of the countries within EU. UK usuallysets an example of an extensively market-based financial system, while German economy
has a reputation of being mainly bank-based. Other EU members fall somewhere in between these two extremes. Thus, in 2005 the ratio of the stock market capitalization to
GDP is 1.26 for the UK and 0.43 for Germany, while for other countries such as Franceand Hungary (the new EU member state) the ratio is equal 0.83 and 0.24, respectively.
The picture is less pronounced if we consider ratio of private credit by deposit moneybanks to GDP. The indicator ranges from 1.6 for the UK and 1.23 for Germany to 0.96
for France and 0.47 for Hungary. The reason for paying attention to differences in the financial architecture is twofold. First, the financial system may significantly influence theinvestment activity of the PE industry (Black and Gilson, 1998a). Second, in our econometric setting the financial environment is most likely to be an important control variable
for unobserved cross-country heterogeneity.
We use the data from two sources. We build our firm-level data-set from the 2008
(November) edition of the Amadeus data base provided by Bureau Van Dijk. The database includes ownership history beginning in 2000. From this base, we retrieve financial ratios, ownership information and other firm-specific variables for companies in all
European countries for the years 2000 to 2008. The country-level data on the nature andevolution of the financial system is adopted from the World Bank Financial Structure
Database (Beck et al., 2000).1
1
The financial structure data were accessed at the http://siteresources.worldbank.org/
INTRES/Resources/469232-1107449512766/FinStructure_2007.xls.

3Our findings suggest that the more financially constrained and risky the company thesmaller is the probability of receiving PE investment. Additionally, we find that growthof the firm does not influence the decision of PE firm to invest. We show that PE firm
is more likely to invest if the company has more shareholder funds. Finally, our results
suggest that larger cash flows decrease the likelihood of attracting a PE investor.
The paper unfolds as follows. In Section 2 we briefly review the literature and sketch
the evolution of the PE industry in Europe in last years and develop behavioral hypotheses based on previous theoretical models and literature. Section 3 presents the empiricalmodel and describes the data. The empirical results and their discussion are provided in
Section 4, while Section 5 concludes.

2 PE investments in Europe in recent years: the generalperspective and behavioral hypotheses
According to the commonly used broad definition in Europe, the activities of PE investors
range from complete buy-outs over minority stakes and expansion capital to start-up
and seed investments. Traditionally, the most active PE market in Europe in terms ofboth fundraising and investing is the United Kingdom, followed by France and Germany(EVCA, 2008). Within few years, buy-outs have become the most important segment in
the PE sector in Europe. The buy-out segment dominates in various countries, including
the countries in Central and Eastern Europe such as the Czech Republic, Hungary, andPoland. Since 2003 more than three quarters of the fundraising of European PE-firms
were going to the European buy-out segment. The investment of these firms into buyouts increased from more than 60 in 2003 to nearly 80 percent in 2007 (EVCA, 2008). In2007(first half of 2008), international financial investors completed 1479(637) European
buy-out deals worth 174(38) billion EUR (CMBOR, 2008).
Buying-out, a PE firm takes control of a company, turns it around, and is willing to sell
it or to float its shares after several years. A considerable share of a buy-out price is traditionally debt financed. The debt share in the total acquisition price generally fluctuates
between 60 and 80 percent (Axelson et al., 2008). The equity capital for these acquisitions
is provided not only by the buy-out funds, but also by the future management of theacquired companies, although to a substantially lesser extent. In the past the debt cap4

ital for European buy-outs generally came from banks and from institutional investors.
Upon completion of the acquisition, the different risk-bearing loan tranches are passed
on to the participating investors and, in some cases, also to the market. In 2008, due tothe financial crisis and the downturn in the market for syndicated and securitized loans
there is a clear tendency towards downsizing of a deal, more specifically, the average deal
shrank to around 70 million EUR in 2008 compared to 118 million EUR during 2007, accompanied by decrease in leverage ratios (CMBOR, 2008). Anecdotal evidence suggests
also that increasing number of PE firms invest in minority stakes either to use the stake asa platform for acquiring majority stake in the future or to gain a seat on the board for the
purpose of increasing and exerting the influence on the target company’s business strategy. So called acquisitions by buy-out companies amount to 106 transactions in the UK
and Central Europe (CMBOR, 2008). Because the median age of targeted companies inout sample is 16 years we are set to scrutinize exactly the buy-out segment (whose targets
are typically mature firms) as this segment receives ever increased attention.
The reasons for PE investors to acquire stakes in companies extend from the demandof family owners or individuals for decreasing their cluster risk to realizing increased
earning opportunities by removing a poorly working corporate governance regime. In
this paper, we consider five hypotheses with regard to activity of private equity firms in
European countries.
Hypothesis 1 Ownership and Control in a Target Firm
Berle and Means brought up the issue of a separation of ownership from control alreadyin 1932. They emphasized that dispersion of shareholding creates for each single shareholder an incentive to free ride on the control intensity of company’s shareholders. As aresult no control occurs, and the management would pursue all kinds of personal goals
to the detriment of the shareholders (Manne, 1965; Williamson, 1967). In the line of thisargument active investors buying a share big enough to cover their control costs and combine this deal with a considerable participation of the management in the ownership ofthe company would reinstate the unity of ownership and control. Dispersed ownershipsignals the possibility for PE investors to gain high returns (Jensen, 1986). If, however,there is already a powerful shareholder present, this signals to PE investors that the potential for value adding is low. Moreover, presence of non-PE financial investor (probablybank) might imply good performance and low risk but also lack of opportunities.
5

Hypothesis 2 Equity or Debt Capacity of a Target Firm
The ability of PE funds to raise a great deal of debt capital for the acquisition of a target company, in addition to equity capital, has had a strong influence on promoting thenegative image of financial investors in many European countries. However, the debt
ratio plays a significant part in corporate management. Jensen (1986) describes high debt
ratio as a carrot and stick strategy. On the one hand, it permits a high concentration of
the share holding and a fairly high participation by the management, which guarantees
high performance incentives. On the other hand, the high debt and the inherent threat of
rapidly losing their position because of the narrow distance to default is like a hard sanction mechanism. In this sense companies that are highly capitalized indicate slack and a
low level of automatically working management control. In addition, highly capitalizedcompanies leave room for savings on corporate taxes. In years with a sufficient low risk
premia on loan financing , the leverage effect would guarantee an immediate increase of
the shareholder return by reorganization of the capital structure (see e.g. The Economist,
2006). The debt can serve as a controlling device and a mean or realizing higher tax savings and shareholder returns.
Hypothesis 3 Maturity of a Target Firm
Risky and financially constraint firms have advantages and disadvantages in attracting
PE investors. Small companies, companies that are owned privately and/or by families,
are often regarded as being opaque and nontransparent for a potential lender or shareholder. Asymmetric information between companies and investors and moral hazard
lead to rationing by lenders (e.g. Bester, 1985) or by the capital market, if the company islisted in an illiquid stock market segment (see Wright et al., 2006). Off-the capital market
equity capital may ease the level of financial constraints. Additional equity injection may
improve the capital structure of these firms. The observed close relationship of PE firms,
in particular buy-out specialists, with the banking sector may enable PE investors to activate additional debt capital. Almeida et al. (2004) argue that constrained firms save highcash out of cash flows to be insured against shortage of liquidity if positive net present
values have to be funded. They find that US-firms that are located in the lower quartileof the size distribution indeed accumulate liquidity while larger firms refrain from doing
so. Baum et al. (2008) show that European firms in the lower quantiles of the size distri6

bution also stockpile cash out of cash flow. In addition, they find that the magnitude of
the stockpiling depends on the country’s financial structure and the development.
The risky companies are quite unlikely to raise debt capital from the capital market(The Economist, 2009a). We measure the risk by company’s probability of default (PD)and since bank is not going to grant a credit to a company once it crosses certain PD
threshold, the only way this risky company can obtain capital is from institutional investor(s). We believe that PE firms could just be such type of investor. PE investors havealso gained a reputation of being specialists to turn around a company (e.g. Thompson
and Wright, 1995).
Hypothesis 4 Management in a Target Firm
PE investors are known to bring fresh managerial skills to a target company. They doinvest when they see a possibility to improve the management and efficiency of a target firm. Since they usually come for relatively short period of time, they are balancing
between making long– and short-term improvements. For example, Williamson (1967)
and Jensen (1986) consider excess cash flow (free cash flow) as complementary to highcapitalization, and as a further indication of a company’s weak corporate governance.
Given little debt service, the management enjoys large discretion in spending money on
unprofitable projects (see also Opler et al. (1999) and Lehn and Poulsen, 1989). PE investor targeting such company may recognize the potential of stopping such practice ofwasting company’s resources by restructuring the companies financing and by initiating
a business model that generates more profitable growth.
However, the common public perception of PE investments in mature firms is different. The targeting of “cash cows” is ascribed to the fact that the generated liquidity canbe used either to buy back shares on the market or pay dividends to shareholders. Bothwould allow a quick amortization and a high return to the PE investment.
Short-tern barometers of firm’s management such as current labor productivity or return may indicate possibilities to PE investor to transfer wealth from employees to shareholders or ripping the profit benefits (Betzer, 2006). Fast growing companies are becoming a powerful magnet for PE investment due to potential to satisfy PE’s financial interest.
However such target companies are not always fond of being bought-out because apparently the control over company will be diluted and the prospects for the future might get
grim when high growth disappears.
7Hypothesis 5 Financial Development of Country in which a Target Firm Operates
Black and Gilson (1998b) suggest that a bank-centered financial system is unable to develop an effective PE industry since its underdeveloped stock markets fail to deliver an
efficient exit channel. However, this supply side-driven conclusion may not hold fromthe point of view of the demand side. Equity capital enables companies to insure themselves against liquidity and income risks. This financing mode is also a “door-opener”
for debt capital. With low significance of capital markets in a country’s financial system,
off-market investment financing is becoming more and more important since possibly existing equity capital gap could be closed using such type of financing. PE funds are oneof the few available sources for off-market equity capital and PE capital outside of thestock-market could in theory at least partly compensate for a lack of public equity capital.
Addressing these behavioral hypotheses would indicate which on two conflicting
views is correct: PE having welfare-improving characteristics, or PE as a mechanism toredistribute the company’s resources and hinder its long-term goals.

3 Methodology and data
Shareholder history The data comes from Amadeus Database (Bureau van Dijk.) The
Amadeus base contains a historical data of shareholders, which runs back to 2000. Thebase enables to identify the type of the shareholder, though the classification of the PE
investment is tricky. We made sure that we really deal with the PE, by inquiring andchoosing the appropriate NACE code of the investor and by comparing the names to theestablished list of the PE firms.2 We have generated a dummy variable ‘d_P’ equal to 1 if
at least one PE investor is among the shareholder in a particular year. Variable ‘d_P_d’ isthen the difference of ‘d_P’ in two subsequent years. Accordingly, that ‘d_P_d’ is equal
to one, implies that the PE investor entered in this year. Among total of 151,243 cases,
the data reveals 3,335 PE entries (2.21 percent). The way the dependent variable is constructed precludes a secondary buy-out (Strömberg, 2007).3 We only look at the cases
when underlying variables suited for the analysis are available. Thus, of approximately
2 A subscription was acquired at http://www.privateequityinfo.com.
3 A secondary buy-out implies that one PE firm acquires the company from another PE firm. Our ‘d_P_d’variable indicates that in period t a company has at least one PE investor and that in period t − 1 PE firm(s)was(were) not among company’s shareholders.

8Table 1: Frequency of PE Entry by years
Year

NtotalNPE Entry

2001
2002
2003
2004
2005
2006
2007
2008
Total

1,219
2,200
13,65913,71722,49029,601
42,53225,825
151,243

4
37
221
295
428
824
1,332
194
3,335

PE Entry, %
0.33
1.68
1.62
2.15
1.90
2.78
3.13
0.75
2.21

250,000 cases available in the data base, the sample reduces to 151,243 observations fit for
the regression analysis. Table 1 presents the frequency of the variable ‘d_P_d’ by years.
We observe increasing tendency in PE investment up to year 2007 and an abrupt plummet
in 2008. Table 1 seems to mirror the aggregate market development in the recent months.
The sharp devaluation of mortgage backed securities and collateralized debt obligation
beginning in the midst of 2007 immediately infected other markets for asset backed securities. Banks are now stockpiling syndicated loans given to PE firms in earlier deals since
the securitization and distribution to the capital market is not feasible. Leveraged financing of PE deals has dried up as inventories of PE loans for earlier deals have grown in thebanks’ books and risk aversion of credit institutions reached new heights. A deepening
financial crisis resulted in a sharp decline of PE investments (e.g. The Economist, 2009b).
PE in the form of venture capital is said to enter young firms while buy-out investors
primarily target older firms. Figure 1 shows the distribution of the age4 of firm at the
moment of PE entrance. The mean and the median are 28 and 16 years respectively.
These numbers indicate quite a large share of mature firms.
Table 2 gives frequencies of the PE entries by countries. United Kingdom, France,
and Spain received the most of the PE investments, although Ireland and Switzerland
have the largest portions of PE entries. Other significant recipients of PE investments are
Germany, Italy, Belgium, Sweden. Norway has the largest number of observations but
lags in terms of attracting PE investors: the share is only 0.4 percent.
4 The age of a company is defined as a difference between year of the observed PE entry and year ofcompany’s incorporation.

9

0

5

10

15

20

mean
median

0

10

20

30

40

50

60

70

80

90

100

120

150

200

250

Age at the moment of PE Entry, years

Figure 1: Distribution of age of firms that received PE investment

Specification The aim of the study is to investigate which micro characteristics of thefirm in previous period attract PE investment in the current period. We thus make use of
the basic binary choice model, the logistic regression.5 As in many empirical applications,
we write logit as

Prob(Y = 1|X ) =exp (α + β X ),1 + exp (α + β X )(1)where X is a vector of explanatory variables for firm i and α and β ’s are parameters to be
estimated. We are primarily interested in regression coefficients. Before presenting our
results, let us turn briefly to description of the vector of explanatory covariates, X .

Explanatory variables To test our hypotheses we generate the following variables.
‘Ownership’ is equal to one if one of the shareholders has either majority of ultimate
ownership, and zero otherwise.6 ‘Financial investor’ is a dummy variable indicating that
non-PE financial investor was among shareholders. ‘Manufacturing’ variable is one if
5 We have chosen logistic over probit model.

Greene (2003) claims that “...it is difficult to justify the
choice of one distribution or another on theoretical grounds.”
6
Since we want to test the hypothesis about dispersed ownership, we also conducted the analysis withvariable ‘Dispersed Ownership’ which is equal to one if any other type of shareholder has at least 40 percent
stake, and zero otherwise. This variable shows the same effect as variable ‘Ownership’ but considerably
reduces the sample because position ‘Direct Ownership, %’ in the Amadeus data base has many missing
values. That is why we prefer to use variable ‘Ownership’ rather than ‘Dispersed Ownership.’10

Table 2: Frequency of PE Entry by countries#

Country

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26

Ireland
Switzerland
Luxembourg
United Kingdom
Austria
Germany
Netherlands
FranceFinlandSpain
GreeceSwedenItaly
Portugal
Belgium
PolandDenmark
Czech Republic
Romania
Hungary
Estonia
Slovakia
NorwayUkraineBulgaria
LatviaTotal

NtotalNPE Entry

PE Entry, %

38
812
13
21,025
197
5,747
2,238
25,231
2,785
21,8902,969
9,081
14,2591,523
11,540
2,406
1,860
855
2,307
121
408
211
20,382
1,819
1,503
23
151,243

14
84
1
1,065
9
254
85
652
52
395
52
140
199
20
143
27
20
9
24
1
3
1
81
3
1
0
3,335

36.84
10.34
7.69
5.07
4.57
4.42
3.80
2.58
1.87
1.80
1.75
1.54
1.40
1.31
1.24
1.12
1.08
1.05
1.04
0.83
0.74
0.47
0.40
0.16
0.07
0
2.21

a primary or secondary NACE code implies that target firm engages in manufacturingsector of the economy.7 ‘Financial constraint’ variable is constructed along the lines of
Almeida et al. (2004). More specifically, ‘Financial Constraint’ is equal to one if firm’s total
assets are below the value of the 30th percentile of distribution of the total asset, and zerootherwise. ‘Risk’ reflects relative probability of default, that is the default probability of
the firm divided by probability of default of peer group. To calculate the probability of de7 Unfortunately, Amadeus data base gives industry affiliation only the last year, 2008. But we think it is

not plausible that manufacturing firm dramatically changes its operation and quits being manufacturing
either primarily or secondary.

11

Table 3: Descriptive Statistics
Variable
Ownership
Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
Equity

Mean
0.076
0.38
0.31
0.27
2.19
0.84
462
1.10
22.8
0.087
0.34

Sd
0.26
0.49
0.46
0.44
4.57
0.37
728
4.32
41.3
0.13
0.25

Min
0
0
0
0
0.03
0.026
0
-28.0
-72.7
-0.52
-0.53

Q1
0
0
0
0
0.18
0.56
118
0.58
3.77
0.028
0.15

Median
0
0
0
0
0.49
0.84
219
1.01
14.3
0.075
0.30

Q3
0
1
1
1
1.61
1.02
444
1.44
34.2
0.14
0.50

Max
1
1
1
1
31.30
3.03
3831
33.40
165
0.59
0.96

fault, Bureau van Dijk uses the MORE rating,8 which is calculated using a unique modelthat references the company’s financial data to create an indication of the company’s financial risk level. Furthermore, Bureau van Dijk claims that the ratings are comparable
across countries−two companies from different countries with the same rating have thesame creditworthiness. We also include a macro variable ‘Market Capitalization’ variablenormalized by real GDP, which was accessed from World Bank web-cite dedicated to financial structure of contries.9 ‘Labor Productivity’ is a operating revenues per employee.
‘Return on Capital’ is return on capital employed. ‘Equity’ is a continuous variable representing shareholder funds. We normalize ‘Equity,’ ‘Cash Flow’ and ‘Labor Productivity’
by total assets to prevent size effects. ‘Cash Flow Growth’ is merely a ratio of current toprevious value of the Cash Flow.
Table 3 presents the descriptive statistics of variables for observations without missing
values. It is clear that ‘Ownership’ is one only in 7.6 percent of cases, while 27 percent offirms are financially constraint. In treating outliers we have winsorized variables ‘Equity’,‘Cash Flow’, ‘Cash Flow Growth’, ‘Risk’ 0.5 percent and variables ‘Labor Productivity’and ‘Return on Capital’ 2.5 percent. Although probability of default ranges form 0 to 1, it
8 See http://www.modefinance.com for details.
9 The

latest version can be downloaded at http://siteresources.worldbank.org/INTRES/
Resources/469232-1107449512766/FinStructure_2007.xls. The values for year 2008 are notderived yet so we assume they are equal to those in 2007. It may seem quite a strong assumption given
events of 2008, but since we conduct a cross-country study, we believe it is reasonable to do so because
indices would not change relatively to each other.

12ranges up to 31 when adjusted for peer probability of default. Such relative relationshipenables to control for risk heterogeneity of the group in which firm is operating. ‘Equity’is quite dispersed, but distributed symmetrically as mean and median values are almost
the same.
In our analysis, we lag (one year) all the explanatory variables, since we are interested
in investigating how last year firm-level characteristics influence receiving investment
from a PE firm in the current year.

4 Empirical results
4.1 Private Equity Entry
In this section, we provide empirical evidence for our five hypotheses by means of regression analysis. We consider three models. The first uses all available observations. It
is reasonable to believe that some observations are influential and might drive all the results. Additionally, quite different financial and economical system might prevent somefactors to reveal their true effect. Indeed quick look at the Table 2 suggests that the sample
of all less original EU−15 countries comprises mostly economies unable to attract PE investment. That is why we also consider regression with original EU−15 countries. Finally,
we consider group of EU−27. Table 5 provides marginal effects after logit estimation. The
descriptive statistics in three sample of variables employed in the regression are shown in
Table 4. It turns out however that the differences are not pronounced as one might think.
First, it is clearly seen that if in previous year a firm had been ultimately owned orowned by the majority, the PE investor is less likely to invest in such a firm. Additionally,
the presence of non-PE financial investor seems to repel PE investor. Therefore, within
Hypothesis 1 we conclude that PE firm is reluctant to invest in a firm, in which it cannot
take over the control.
Second, positive and significant coefficient at ‘Equity’ variable implies that PE investment is likelier the larger the equity of the firm. It is a long-standing policy debate wether
or nor PE investors come to a firm in order to extract something valuable for own good.
Our analysis seems to provide empirical evidence that PE firms seem to target firms with

13

Table 4: Descriptive Statistics
Variable

Mean

Sd

Min

Ownership
Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
Equity

0.076
0.38
0.31
0.27
2.19
0.84
462
1.10
22.8
0.087
0.34

0.26
0.49
0.46
0.44
4.57
0.37
728
4.32
41.3
0.13
0.25

0
0
0
0
0.03
0.026
0
-28.0
-72.7
-0.52
-0.53

Ownership
Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
Equity

0.089
0.35
0.31
0.29
2.34
0.91
491
1.07
19.9
0.080
0.34

0.29
0.48
0.46
0.45
4.79
0.32
747
4.31
37.7
0.12
0.25

0
0
0
0
0.03
0.240
0
-28.0
-72.7
-0.52
-0.53

Ownership
Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
Equity

0.088
0.34
0.32
0.29
2.34
0.87
473
1.07
19.7
0.081
0.34

0.28
0.47
0.47
0.45
4.81
0.36
737
4.34
37.6
0.12
0.25

0
0
0
0
0.03
0.026
0
-28.0
-72.7
-0.52
-0.53

14

Q1
MedianEntire Sample
0
0
0
0
0
0
0
0
0.18
0.49
0.56
0.84
118
219
0.58
1.01
3.77
14.3
0.028
0.075
0.15
0.30
EU−15
0
0
0
0
0
0
0
0
0.18
0.56
0.66
0.88
129
236
0.58
1.00
3.61
13.6
0.026
0.070
0.16
0.31
EU−27
0
0
0
0
0
0
0
0
0.18
0.55
0.58
0.85
120
225
0.57
1.00
3.48
13.4
0.026
0.070
0.16
0.32

Q3

Max

0
1
1
1
1.61
1.02
444
1.44
34.2
0.14
0.50

1
1
1
1
31.30
3.03
3831
33.40
165
0.59
0.96

0
1
1
1
1.74
1.20
475
1.39
31.3
0.13
0.50

1
1
1
1
31.30
2.69
3831
33.40
165
0.59
0.96

0
1
1
1
1.73
1.14
459
1.41
31.1
0.13
0.51

1
1
1
1
31.30
2.69
3831
33.40
165
0.59
0.96

Table 5: Marginal effects after logit estimation of PE investment determinants in European Companies. The associated t-statistics arereported in parentheses.
Variable

ALL

EU−15

EU−27

Ownership−.0102884***(−13.13)−.0135132***(−21.07).0034802***(−5.03)−.005809***(−9.06)−.0008154***(−7.59).0159352***(−23.98).0011275***(−5.76)
2.82E−08(−0.06)0.0001133(−1.6)−.0001462***(−10.54)−0.0063271(−1.89).0070495***(−4.88)−.0139768***(−14.84)−.0146839***(−18.76).0033496***(−3.82)−.0077625***(−9.53)−.0010961***(−8.09).0150157***(−12.8).0016561***(−6.58)−9.82E−07(−1.64)0.0001676(−1.87)−.0001891***(−10.35)−0.0069146(−1.63).0066156***(−3.53)−.0131894***(−14.82)−.0138068***(−18.78).0028519***(−3.47)−.0072262***(−9.38)−.001055***(−8.25).0170296***(−16.84).0016025***(−6.74)−6.27E−07(−1.12)0.0001466(−1.74)−.0001755***(−10.23)−0.0050691(−1.26).0052178**(−2.97)

151,243

120,396

128,230

Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Year
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
EquityNtotal*, **, and *** indicate statistical significance at the 5%, 1%, and 0.1% test levels,
respectively;

low debt to profit from an increase in leverage. This may add value by disciplining managers, but also redistributes profits towards shareholders.
Third, We have seen that the age of target firm indicates that PE firm prefers relatively
mature target firm. The regression analysis confirms this conjecture as the coefficientin front of variables ‘Financial Constraint’ and ‘Risk’ are negative and significant. The
way we constructed the ‘Financial Constraint’ variable, implies that PE is cautious about
15

smaller firms since they could be relatively young and less well known, which makes
them more susceptible of capital market fluctuations. In the light of Hypothesis 3 thus,
private equity firm seems to prefer a safe path.
Fourth, in addressing the Hypothesis 4, we looked at short– and long term indicatorsof management performance. Although it is reasonable to expect that the high growthfirm in terms of cash flow is capital hungry and thus would attract a PE investor, ouranalysis does not support this hypothesis. The regression implies that PE firm makes
its decision to invest in a company irrespective of this company’s growth of cash flow.
Additionally, our regression analysis implies that PE firm rather comes to a firm withlarge cash flow. This seems to contradict the wide-spread view that PE firms enter tonourish themselves from cash-cows. Nor PE firm is interested in labor productivity of the
firm.
Finally, PE investors seek to invest in countries whose relative capitalization is bigger.
Although this macro variable is used mostly as a control for unobserved heterogeneity ofcountries, larger capitalization implies better conditions and/or availability of financing
for a PE firm. With regard to the Hypothesis 5, PE seems to be a complement rather than asubstitute to public equity, consistent with the supply-side argument of Black and Gilson(1998a).
Discarding the slight changes in magnitudes of the coefficients, but taking only significance into account, the results suggest that major conclusions on tested hypotheses found
for the entire sample hold for EU−15 and EU−27 groups of countries. This is expected
given minor differences in descriptive statistics presented in Table 4.
We have also controlled for the year in which PE entry ensued to test the influence ofa change in the financial environment over time. It seems that time has positive effect,
implying that every year there more PE entries. We also confirm a view that PE firm ismore likely to invest in manufacturing firm, although they comprise only third of oursample. Another concern is the Norway’s very large number of observations, but verysmall number of PE entries. We have reran the regression without Norway (The tablewith results appears in appendix), but this does not change our major conclusions.

16

Table 6: Frequency of PE Exits by years
Year

NtotalNPE Entry

2001
2002
2003
2004
2005
2006
2007
2008
Total

1,269
2,297
13,911
14,04922,97830,12543,24027,304
155,173

4
13
115
141
256
325
861
584
2,299

PE Entry, %
0.32
0.57
0.83
1.00
1.11
1.08
1.99
2.14
1.48

4.2 Private Equity Exit
We have created the variable ‘PE Exit’ is the same fashion we constructed variable ‘PE
Entry.’ More specifically, ‘PE Exit’ is a binary variable which is equal to one if there isnone PE investor among shareholder in year t and there is at least one PE investor in yeart − 1. In this section we would like to investigate the exits of private equity firms withinsame five behavioral hypotheses. In other words, what do PE investors leave behindwhen they quit a firm. The frequencies of ‘PE Exits’ by years and countries are presented
in Tables 6 and 7, respectively. Figure 2 shows the age of the firm at the moment of exit ofPE.
Table 6 suggests much smaller activity of PE investors in terms of quitting firms during
2001−2008. Figure 2 implies that PE firms have been exiting both young and mature firms
with mean and median being almost the same at those for PE Entries. Furthermore, PE
turnover is again mostly take place in United Kingdom, France, and Spain. These threefacts suggest PE firms act consistently and gradually: they exit about the same firms andin about the same countries as they enter.10
We employ the same set of variables to investigate what drives exit of PE investor. The
results of marginal effects after logit estimation of private equity exits appear in Table 8.
Several observations from Table 8 are worth mentioning. PE investor is likely to leave
if it was not able to get majority ownership in the firm. It is however, less likely to leave
10 We do not have enough data to prove PE firms enter and exit in cycles, but we feel it might be the case.

17

mean

0

5

10

15

median

0

10

20

30

40

50

60

70

80

90

100

120

140

170

Age at the moment of PE exit, years

Figure 2: Distribution of age of firms that PE investor exited

if non-PE financial investor remains. The latter fact can be explained by access to funds,
which might be provided by such non-PE financial investor.
The regression analysis suggests that PE stops caring about firm’s being risky or financially constraint when it leaves. (Although marginally significant for EU−15 and EU−27
group of countries.) It implies that exposure of the firm to market fluctuations does not
influence the decision of PE investors to leave, while it does a lot in case of PE Entry.
PE firm completely sells shares of a firm in a good macro environment, which speaks
for public capital substitution argument. And more exits happen as time passes by, giving
some support of cycle conjecture.
When leaving PE firm care that operating revenue per employee is positive, which
would show off that firm is expanding. Other management indicators has either only
marginally significant effect (return on capital), or not significant at all, which suggests
PE’s exit is not influenced by the state of management of firm that it is going to leave in
the next year.
Finally, and most interesting, PE investor is very interested (effect if significant at any
conventional level) in strong shareholders’s position with an aim to sell its shares as expensive as possible. PE investor has however managed to milk the cash-cow: that cash
flow get scarce, the probability that PE leave increases. Combining findings of Tables 518

Table 7: Frequency of PE Exits by countries#

Country

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26

Germany
United Kingdom
Netherlands
Czech Republic
FranceSwitzerland
PolandIrelandSwedenFinland
Austria
Belgium
Spain
GreeceItaly
Estonia
Denmark
Portugal
Romania
Slovakia
NorwayBulgaria
Hungary
LatviaLuxembourg
Ukraine
Total

NtotalNPE Entry

PE Entry, %6,109
22,8762,332
791
25,962
1,024
2,355
58
9,139
2,884
198
11,46722,2993,042
14,335
410
1,881
1,550
2,322
204
20,462
1,497
121
23
11
1,821
155,173

153
534
48
15
467
18
41
1
142
44
3
163
312
40
186
5
17
13
16
1
76
4
0
0
0
0
2,299

2.50
2.33
2.06
1.90
1.80
1.76
1.74
1.72
1.55
1.53
1.52
1.42
1.40
1.31
1.30
1.22
0.90
0.84
0.69
0.49
0.37
0.27
0
0
0
0
1.48

and 8 we claim that PE investor enters firm with big equity and leaves it with such, butwhile it seems not to be attracted by available cash, it strives to leave the firm, when cash
flow reduces.

19

Table 8: Marginal effects after logit estimation of PE exit determinants in European Companies. The associated t-statistics are reported in parentheses.
Variable
Ownership
Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Year
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
EquityNtotal

ALL

EU−15

EU−27

.0078799***.0061153***.0062746***(7.38)(5.21)(5.55)−.0118325*** −.0122243*** −.011955***(−22.97)(−19.86)(−20.51).0029846***.003621***.0033***(5.35)(5.09)(4.92)−.000431−.0008987−.0007965(−0.80)(−1.33)(−1.24)−.0001223−.0001722*−.0001781*(−1.80)(−2.02)(−2.19).0049819***.0046496***.0051684***(8.64)(4.91)(6.21).0026625***.0033938***.0033533***(15.26)(15.53)(16.10)1.74e−06***
1.71e−06***
1.73e−06***(5.82)(4.39)(4.67)−.0000721−.0001152−.0001052(−1.28)(−1.61)(−1.55)−.0000243*−.000027*−.0000237*(−2.50)(−2.14)(−1.97)−.0097426*** −.0126697*** −.0117913***(−3.78)(−3.88)(−3.79).004901***.0053861***.0047217***(4.26)(3.63)(3.37)
155,173

124,143

131,866*, **, and *** indicate statistical significance at the 5%, 1%, and 0.1% test levels,
respectively;

20

5 Concluding remarks
In the recent years the policy makers have become increasingly concerned with reconciling two contradicting views on the role of PE for the economy in general and companies
in which they invest in particular. First, it is conjectured that engagement of a PE investor may and does provide the financing needed for development of the company, andthus such engagement constitutes positive effect. Second, some share a view that PE investor enters the company, that has good perspectives, in order to squeeze company’s
cash resources and exploit company’s good standing, therefore implying negative effect.
However, to the best of our knowledge, testing these conceptually opposite hypotheseswith good quality data is broadly missing. This paper provides empirical evidence forbetter understanding what makes PE firm invest using comprehensive micro-data for 28
European countries.
Our results suggest that before investing PE investors seem to care and are less willingto invest if majority or whole shareholder is present. The try however to leave the firm
if they cannot take over the control of this firm. Additionally we find that a financiallyconstrained and risky company is less successful in attracting investment from a PE firm.
But this two factors do not influence decision of PE to leave. Further, when investing PE
firm does not show more interest in firms with better management, but they do exit thefirm when it exhibits positive labor productivity. Most remarkably, while PE both invests
and leaves the firm that has big shareholder funds, it seems not to care about presence ofstrong cash-flow, but tries to exit the firm when cash gets scarce.
The proposed analysis provides little support for the hypothesis that private equity
investments are motivated by the aim to add value. We would like to emphasize though,that one has to be cautious when evaluating the results. First, the purpose of our analysis
was a cross-country comparison and therefore we concluded for an ‘average’ European
company. Nevertheless, including the macro control variable into regression has showsthat countries are statistically significantly heterogeneous and possibly separate conclusions have to be drawn for each country. This is however possible only for a handful ofcountries due to data availability. Second, although we believe that our conclusions arerobust, we would like to acknowledge that some countries are really badly represented
and broad conclusions for such countries are separate regions might not necessarily hold.

21

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6 Appendix
Table 9: Marginal effects after logit estimation of PE investment determinants in European Companies. The associated t-statistics arereported in parentheses. Norway is excluded.
Variable

ALL

EU−15

EU−27

Ownership−.0130595***(−14.66)−.013061***(−17.91).004021***(−4.89)−.0079295***(−10.46)−.0010799***(−8.37).0165938***(−20.93).0016521***(−7.04)−6.40E−07(−1.15)0.0001452(−1.73)−.0001778***(−10.08)−0.0039256(−0.99).0044613**(−2.58)−.0139835***(−14.82)−.0146926***(−18.75).0033867***(−3.86)−.0077646***(−9.52)−.0011323***(−8.28).0150021***(−12.77).0016654***(−6.6)−9.63E−07(−1.61)0.0001665(−1.88)−.0001998***(−10.59)−0.005677(−1.34).0064563***(−3.46)−.0131885***(−14.79)−.0138087***(−18.77).0028826***(−3.51)−.0072254***(−9.37)−.0010922***(−8.46).0170174***(−16.81).0016115***(−6.77)−6.05E−07(−1.08)0.0001457(−1.74)−.0001867***(−10.51)−0.0037925(−0.95).0050428**(−2.88)130,861

120,396

128,230

Financial investor
Manufacturing
Financial Constraint
Risk
Market Capitalization
Year
Labor Productivity
Cash Flow Growth
Return on Capital
Cash Flow
EquityNtotal*, **, and *** indicate statistical significance at the 5%, 1%, and 0.1% test levels,
respectively;

24