Collective Monitoring and Investment Illiquidity in Leveraged Buyout from the Private Equity Fund

Extending from Lerner and Schoar's (2004) fund manager's perspective for illiquidity puzzle of the private equity fund, we take the investor's perspective. This paper examines the roles that investment illiquidity, along with bounded rationality of the fund managers and rent-seeking behavior in their investment decisions for leveraged buyouts. Investors employ collective monitoring to screen out fund managers who might misuse their discretionary rights to engage buyout deals. We aim at discerning whether or not such discretion improves the choice of buyout targets and fund performance.Our findings show that the performance of buyout funds persists and affects the choice of the club deal as one major collective monitoring mechanism. This paper contributes to our understandings of the fund manager's investment behavior in buyouts as follows. First, the performance of buyout funds has improved for at least two years starting with the vintage year 1990 or later. The phenomenon that fund performance affects the choice of club deals is consistent across a variety of private equity funds, such as buyout, venture, growth, and mezzanine funds. Moreover, risk preference does not affect choice of club deals directly; instead, it has a moderating effect on choice of club deals through its interaction with the location of reference point for risk aversion. Finally, both fund size and fund sequence have U-shaped relations to the choice of club deals, while deal value of buyouts is related positively to the choice of club deals