Do Private Equity Funds Manipulate Reported Returns?

Some do, and it backfires.

In a working paper by Gregory W. Brown, Oleg R. Gredil, and Steven N. Kaplan they studied cash flows and NAV reports for a sample of 2,071 buyout and venture funds. The study was motivated by the potential incentive for fund managers to exaggerate performance to attract investors to a follow-on fund. They looked for evidence consistent with funds manipulating their self-reported net asset values around the time commitments are raised for a next fund.

The results of this analysis suggest that exaggerated NAVs are associated with lower probability of raising a follow-on fund. When they examined performance of funds that are unsuccessful at raising a follow-on fund, they observed clear evidence of performance reversals toward the end of fund life that is consistent with investors seeing through attempts of performance manipulation. Furthermore, they saw that conservative reporting and credible signaling (via distributing capital back to investors) have, on average, stronger effects on fundraising-odds than market-adjusted performance. The results were similar for both buyout and venture funds.

The study concludes that top-performing fund managers may try to safeguard their long-term reputation from bad luck by reporting conservative NAVs. They are more likely to do this when it does not jeopardize their high relative performance rank. Correspondingly, limited partners punish fund managers for the appearance of overstated performance by not providing capital to subsequent funds.

The findings corroborate the evidence in another study that private equity fundraising outcomes are largely determined by sophisticated counterparties.

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