Economics Job Talk

Abstract: Private equity (PE) funds are funded by investors that commit to providing capital on demand. I show that the composition of these investors influences PE investment due to their heterogeneous costs of holding illiquid assets after liquidity shocks. The variation stems from differences in the liability structure across investors. During periods of abnormal insured losses from natural disasters, funds with more committed capital from property and casualty insurers invest less compared to other nearly identical funds. This investment distortion results in lower realized fund returns. However, the shock transmission from investors to PE funds is attenuated when there is a liquid secondary market for investors' fund stakes and when funds can enforce drawdowns more effectively. To mitigate liquidity shocks ex ante, funds exposed to shock-prone investors accelerate drawdowns, leading to inefficient investment. Overall, the growing interconnectedness between PE and other financial markets could create systemic risk and have capital allocation implications.