Private equity returns, cash flow timing, and investor

choices
Stephannie Larocque,∗ Sophie Shive† and Jennifer Sustersic Stevens‡§

June 2, 2019

Abstract

In a comprehensive sample, private equity fund lifetimes average 10 years but their
cash flow durations average 4 years with substantial variation across funds. This creates
cash management challenges for investors and makes the internal rate of return (IRR)
an incomplete measure of performance. Do investors consider these facts when choosing
between funds? We find that the portion of IRR that stems from cash flow timing -
more than half the IRR on average - persists across a private equity firm’s funds and
negatively predicts future performance, but facilitates fundraising, especially among
funds of funds, foundations, private pension funds, and relatively unsuccessful investors.

∗
Mendoza College of Business, University of Notre Dame, larocque.1@nd.edu.
†
Corresponding author. Mendoza College of Business, University of Notre Dame, sshive1@nd.edu.
‡
Ohio University College of Business, stevenj1@ohio.edu.
§
We thank Marc Crummenerl, John Donovan, William Goetzmann, Ernst Maug, Ludovic Phalippou,
Stefan Ruenzi, Paul Schultz, Yannik Schneider, Florin Vasvari, Michael Weisbach, conference participants
at the Paris Dauphine 11th Annual Hedge Fund and Private Equity Conference and seminar participants at
the University of Frankfurt, the University of Mannheim, the University of Notre Dame, Ohio University,
and York University for helpful comments. We also thank George Jiang and Xue Li for excellent research
assistance.
 We have seen a number of proposals from private equity funds where the returns are really
not calculated in a manner that I would regard as honest ... It makes their return look better
if you sit there a long time in Treasury bills. - Warren Buffett; May 4, 2019

1 Introduction

Private equity is a fast-growing asset class, rivaling hedge funds with over $3.4 trillion under
management in 2018, according to Preqin.1 One potential driver of the rapid rise of private
equity is the attractive returns that private equity managers (general partners, or GPs) offer
investors (limited partners, or LPs). The internal rate of return (IRR) is the headline measure
of private equity returns and is used by data providers to rank funds relative to peer funds of
the same vintage. Beginning with Kaplan and Schoar (2005), a large and growing literature
examines the size and risk profile of private equity returns, typically focusing on IRRs or
public market equivalents.2 Recent research documents that the reported IRRs of past funds
affect both a private equity firm’s ability to fundraise (Brown, Gredil, and Kaplan (2018))
and private equity firm compensation (Gompers and Lerner (1999); Phalippou (2009); and
Hochberg, Ljungqvist, and Vissing-Jørgensen (2014)).
Whereas prior literature takes the timing of private equity cash flows as given, we estimate
the effects of cash-flow timing on reported IRRs and explore whether and to what extent
private equity investors consider these effects in their investment decisions. Private equity
investments present cash flow profiles that differ from those of other asset classes because
fund manager, rather than investor, discretion largely dictates the timing of cash flows into
and out of the fund. Since invested capital is often less than committed capital over the life
1
Private equity set to surpass hedge funds in assets, Financial Times, October 24, 2018.
2
Public market equivalents, or PMEs, compare the return on an investment in a private equity fund to
the return on a contemporaneous investment in a public equity index fund.

1
of the fund, investors must be skilled at putting varying amounts of committed capital to
good use before and after it is needed by the fund.
We assert that the IRR provides an incomplete picture of private equity returns because
the return that the investor actually earns on committed capital throughout the life of the
fund depends on both the cash flow choices of the general partner and on the investor’s
skill and opportunities for reinvesting capital outside the fund. In fact, the more skilled the
private equity firm is at market timing, the less plausible the assumption that intermediate
cash flows can be reinvested at the IRR.3 As many finance textbooks show, the calculation
of IRR assumes that committed capital earns the IRR regardless of whether the capital is
invested inside or outside the fund. To see why this results in an incomplete picture of
private equity returns, and may mislead investors who focus exclusively on IRR, consider
two funds. Fund A calls $100 from investors in year 4 and returns $120 in year 5, reporting
an IRR of 20%. Fund B calls $100 in year 1 and returns $500 in year 10, reporting an IRR
of 20%. An investment in Fund A earns 20% for one year; an investment in Fund B earns
20% each year for 10 years. Both funds report an IRR of 20%, but fund B is the preferable
investment if the investor cannot earn 20% on her capital when it is invested outside of the
fund. As this example shows, cash flow timing and the corresponding cash flow duration of
the fund can greatly impact the cash earned by the investor for a given IRR.
We use data on 6,294 private equity funds from Preqin, 2,702 of which have cash flow
data, in a sample spanning 40 years. We find that duration, calculated as (undiscounted)
cash-flow-weighted fund life, averages 4.13 years while mean realized fund life is 10.13 years.
3
Jenkinson and Sousa (2015) show that conditions in the debt and equity markets affect exit choice.
Kacperczyk, Nieuwerburgh, and Veldkamp (2014) find that for mutual fund managers, market timing ability
and security selection ability are related, but unlike private equity firms, mutual fund managers must manage
the entirety of investors’ capital throughout its time in the fund.

2
Fund durations also vary widely, with a standard deviation of almost 2 years.4 Considering
that our sample’s mean IRR is 13.2%, a 2-year increase in the amount of time the capital is
in the fund would result in an additional 28.1% cash return on capital, with compounding.
We next compare funds’ reported IRRs to the returns implied by their cash-on-cash
multiples, or “multiple-implied returns”, which offer a benchmark measure of the return to
private equity investors over the entire life of the fund and are largely unaffected by cash
flow timing.5 This measure implicitly assumes that committed capital earns zero returns
while it is outside the fund, which, while extreme, has the advantage that fund-level cash
flow data are not required for its calculation. We study differences between the IRR and
the multiple-implied return; we call the difference the “return gap”. While multiple-implied
returns are earned by all investors, return gaps are fully earned only by investors who are able
to reinvest their capital at the IRR while it is outside the fund. We expect any investment
with intermediate cash flows and a multiple greater than one to have a positive gap, as a
byproduct of the opportunistic investment process in which private equity firms specialize.
To the extent that some GPs aim to time investments to employ capital only when it earns
maximum returns, or to the extent that GPs manage cash flows or IRRs, return gaps should
be higher and persist across the GP’s funds. A GP policy of trying to employ capital
throughout the life of the fund would make the gap persistently lower. In our sample, we
confirm that the fund types that tend to have more volatile cash flows and those where the
GP has more discretion in the timing of cash flows tend to have higher return gaps. For
4
In the subset of these funds that are liquidated, duration averages 4.68 years with a standard deviation
of 1.81 while fund life averages 12.04 years. For liquidated funds, we calculate fund life as the time it takes
for the LP to receive 95% of total cash flows from the fund.
5
The cash-on-cash multiple is the ratio of cash distributed to a fund’s investors to cash contributed
into the fund by the investors during the fund’s life. See, for example, Lopez-de-Silanes, Phalippou, and
Gottschalg (2015) and Phalippou, Rauch, and Umber (2018). Cash-on-cash multiples could be manipulated
if the fund allows for recycling of capital returned during the investment period of the fund’s life. Any
upward manipulation of this multiple would weaken our results.

3
robustness, we explore alternate assumptions such as reinvestment of non-committed funds
at the market rate of return as in the modified internal rate of return (MIRR), which assumes
that cash flows are invested in the market portfolio while they are outside the fund, for the
subset of funds with cash flow data.
Focusing on the return gap, we first examine whether it persists for a given GP and thus
reflects investment style. In both quartile transition probabilities and regression analyses,
we find some evidence of persistence in the return gap, controlling for size, vintage, and fund
type fixed effects. Next, we find that, while the multiple-implied return of a current fund is
positively related to the multiple-implied return of the private equity firm’s subsequent funds,
the current fund’s return gap is negatively related to the future fund’s multiple-implied return
for many fund types and vintages. In the full sample, a one standard deviation increase in
the gap is associated with a multiple-implied return of the subsequent fund that is 0.4%
lower. The negative relation of the return gap to future performance suggests that it is not
a measure of skill and that some resources are wasted on generating high IRRs.
Sophisticated investors may not be fooled by the effect of cash-flow timing on IRRs,
especially if they can observe these effects with access to past funds’ cash-on-cash multiples
and cash flow data. Moreover, if private equity investors are easily able to invest committed
capital in similar-yielding investments while it is outside the fund, we do not expect the return
gap to be related to a private equity firm’s future fundraising ability. Rather than taking
these risks, investors might prefer to reinvest with private equity firms that have past funds
with longer durations and lower historical return gaps, thus minimizing the need for cash
management. We conduct several analyses of whether return gaps affect investors’ decisions.
At the fund level, we find that, although a current fund’s return gap is unrelated to the
probability of the private equity firm raising a subsequent fund, it is positively associated

4
with the size of a private equity firm’s follow-on fund (conditional on its existence). A
return gap that is one percent higher in the current fund is associated with a 2.7% larger
size in the subsequent fund. In contrast, the current fund’s multiple-implied return and
MIRR are not related to the size of the subsequent fund. At the investor level, when we
regress an indicator variable for whether the investor invests in the private equity firm’s next
fund (again, conditional on its existence), we find positive and significant coefficients on the
current fund’s return gap for multiple investor categories (funds of funds, foundations, and
private pension funds), and no significant negative coefficients. In addition, we build on
Cavagnaro, Sensoy, Wang, and Weisbach (2018), who point out that skill can vary greatly
within investor classification. We compute versions of their measure of skill to classify
investors, and find limited evidence that the relatively more successful investors weight the
return gap less heavily in their decision to reinvest in the GP’s subsequent fund. Overall,
our results suggest that return gaps influence investment decisions for a broad cross-section
of investors.
Taken together, our results suggest private equity investors might not fully account for the
cash flow timing implications of IRR in their investment decisions. The next section provides
background on the private equity industry and the IRR, and describes the computation of
the return gap in more detail before moving on to the empirical tests.

2 Private equity and IRR background

2.1 Private equity background

Private equity firms manage one or more funds that hold equity or debt stakes in private
companies. In the fundraising stage, the private equity firm obtains capital commitments

5
from investors. As it is uncertain when investment opportunities will arise, committed
capital must be available with a typically 10 day notice during the investment period, which
is usually the first few years of the fund’s life.6 This forces many investors, especially those
who have too little capital to diversify across multiple private equity funds, to hold low-risk,
low-yielding assets, or to shoulder investment risk on the committed capital.7 As the fund
matures and divests its portfolio companies, it returns capital and profit, less agreed-upon
fees, to the fund’s investors. Limited partnership agreements (LPAs) typically stipulate ten-
year fund lives, but extensions are possible. Capital, sometimes in the form of locked up
IPO shares, is returned to investors throughout the fund’s life at the discretion of the private
equity firm. Finally, given that some distributions occur before calls, funds often never have
the entire committed amount invested at any given time during the fund’s life.
While exogenous economic forces likely drive most of private equity firms’ decisions about
when to call capital and harvest investments, given uncertainty about the economically
optimal timing choice, the private equity firm has an incentive to call capital late and harvest
investments early or pay large early dividends, in order to maximize the fund’s IRR. A fund
could also borrow money in order delay capital calls from investors. This “subscription line”
financing shortens the investment period and thus increases the fund’s reported IRR, but
decreases the fund’s cash-on-cash multiple due to the interest paid. To illustrate this, we
present a typical example of a private equity fund’s cash flows in Appendix A, and the effect
on fund-level IRR of a hypothetical subscription line financing arrangement.8
6
See MJ Hudson’s Alternative Insight (February 2019). Investors who are late in meeting calls may be
subject to a lawsuit, punitive interest rates, or loss of stake. Note that this is not simply illiquidity, as the
investor is unable to pay a fee or give advanced notice in order to change the timing of cash flows.
7
In 2009, however, even the Harvard University endowment was forced into fire sales on the sec-
ondary market of $3 billion of its $11 billion worth of commitments to private equity funds, due to
the losses in its portfolio and an overcommitment of the capital it had allocated to private equity
(https://harvardmagazine.com/2009/09/sharp-endowment-decline-reported).
8
Subscription loan interest rates are typically low because the loan is backed by investors’ firm commit-

6
 An increasingly sophisticated academic literature examines the size and risk profile of
private equity returns, typically focusing on IRRs or PMEs (see Kaplan and Schoar; 2005
and Korteweg and Nagel; 2016). Kaplan and Schoar (2005) and Phalippou and Gottschalg
(2009) find that, after fees, private equity funds substantially underperform public mar-
kets, but Harris, Jenkinson, and Kaplan (2014) find that private equity funds outperform.
Sorensen, Wang, and Yang (2014) argue that this outperformance is inadequate to com-
pensate investors for the substantially greater risk, leverage, and illiquidity associated with
private equity investments. Korteweg and Nagel (2016) generalize the PME using a stochas-
tic discount factor methodology and find that venture capital funds underperform after fees,
but direct investments in startups outperform public benchmarks.9 Ang, Chen, Goetzmann,
and Phalippou (2018) find that private equity investors may at best break even compared
to investing in a portfolio of small, illiquid stocks.
Private equity fund performance, through the IRR, affects a private equity firm’s ability
to fundraise (Brown, Gredil, and Kaplan (2018)). Moreover, the private equity firm’s com-
pensation is tied to the funds returns.10 We seek to provide further insight into reported
IRRs by decomposing them to estimate the effects of cash-flow timing on reported IRRs, as
discussed below.
ments. While subscription line financing’s original purpose was to render capital calls more predictable for
investors, today, LPAs allow for subscription lines to be outstanding for 180 or even 360 days (MJ Hudson’s
Alternative Insight - February 2019).
9
While the PME gives investors a useful comparison to returns that might have been earned in an index
fund during the same time period, it does not account for the fact that the GP chooses the timing of the
fund’s cash flows and that the investor must find a home for the capital while it is outside the fund.
10
Compensation often follows the industry standard of 2/20: 2% management fee on all invested capital
and 20% carried interest on the total return, typically after a hurdle rate of return is achieved. Whether the
private equity firm can begin collecting carried interest can be based on the fund’s IRR surpassing a pre-set
hurdle rate. Gompers and Lerner (1999); Phalippou (2009); Chung, Sensoy, Stern, and Weisbach (2012);
and Hochberg, Ljungqvist, and Vissing-Jørgensen (2014) discuss private equity industry compensation.

7
2.2 Decomposition of IRRs

We seek to compare the reported IRR to the rate of return earned by an investor who leaves
capital in the fund from inception to the end of the fund’s life. In the extreme case, if no
return is earned on the capital outside of the fund, the cash-on-cash multiple offers a better
gauge of the return actually earned by investors over the fund’s life. We can calculate the
return implied by the fund multiple for the life of the fund:

MultipleReturn = (M ultiple)1/T − 1, (1)

where T is the life of the fund and Multiple is the fund’s reported cash-on-cash multiple.
For instance, a multiple of 2 would signify a 100% return over the life of the fund, which is
a 7.2% annual return over a ten-year fund’s life. We then compute the difference between
the reported IRR and this rate of return.

Gap = IRR − MultipleReturn (2)

A gap between reported IRR and the rate of return implied by the fund’s cash-on-cash
multiple will naturally arise due to the existence of intermediate cash flows that effectively
shorten the investment horizon.11 This will tend to make reported IRRs higher than multiple-
implied returns when the multiple is greater than one, and lower when the multiple is less
than one. Thus, we expect a negative gap when IRR is negative.
While investors are subject to capital calls and returns of capital at unknown dates,
11
Kacperczyk, Sialm, and Zheng (2007) compute a return gap for mutual funds by comparing the return
reported by the fund to the return earned by the fund’s beginning-of-quarter holdings. Our measures are
similar in name only. While their measure, which takes the reported return as the true return to investors, is
positively related to a fund manager’s skill in managing intra-quarter trades, our measure uses the multiple-
implied return as a lower bound for the true return on investors’ capital during the fund’s lifetime.

8
they can most likely earn some positive return on the capital while it is outside the fund.
Some investors compute a modified IRR, or MIRR, taking into account the returns they
think they can earn on the capital while it is not in the fund. The riskier the alternative
investment vehicle, however, the more likely it is that investors may not be able to make
capital calls from the fund and suffer financial consequences. In some of our analyses, we
use the MIRR, which we compute by assuming that cash is invested in the market portfolio
while it is outside the fund. We then compute the M IRRgap as follows:

MIRRgap = IRR − MIRR (3)

This MIRRgap is the difference between the IRR and a plausible annualized return that an
investor could have earned if she had access to a liquid market index fund for any cash that
was not invested in the private equity fund. While this measure is potentially more realistic,
it requires cash flow data and thus restricts the sample size.

3 Data

We obtain private equity fund data from Preqin’s Performance, Fund Summary, Cash Flow,
and Investor modules. Preqin obtains data through voluntary input from fund investors
and through Freedom of Information Act (FOIA) requests. Preqin data has been used in
other academic studies including Ewens, Jones, and Rhodes-Kropf (2013) and Ang, Chen,
Goetzmann, and Phalippou (2018). We focus on both the reported IRR and the multiple-
implied return for the entire life of the fund; thus our primary analysis retains funds for
which Preqin reports both the IRR and cash-on-cash multiple for the life of the fund. If a
fund is not yet liquidated, we rely on its latest reported interim IRR and we require that

9
the fund is at least three years old as of 2017. Interim reported IRRs assume that fund-
reported net asset values (NAVs) are equal to the market values of these assets. Private
equity firms have historically had some leeway in computing interim asset values for their
investors. This has attracted the attention of both researchers and the SEC.12 Conservatively
underreporting NAVs, especially early values, generally boosts the final IRR [see Phalippou
(2011)]. However, GPs normally raise their next fund before the first fund is liquidated, and
investors use the prior fund’s interim IRR to evaluate participation in a subsequent fund.
Our sample comprises 6,294 total private equity funds with vintages between 1971 and
2014 for which we can observe the fund’s IRR and cash-on-cash multiple. Of these 6,294
funds, 3,662 funds have a predecessor fund from the same GP with a vintage that is at least
3 years earlier. Of these 3,662 funds, 862 are liquidated. For some tests, we require fund cash
flow data, and thus use a sub-sample of 2,702 funds, of which 364 are liquidated. Figure 1
shows the number of funds in the sample by vintage year. Summary statistics for the full
sample of private equity funds and the subsample that have a predecessor fund appear in
columns 1-4 of Panel A in Table 2. Closed fund size (FundValue) averages $621.8M with a
median of $250M. Reported average (median) IRR (IRR) is 13.2% (11.1%), and cash-on-cash
multiple (Multiple) is 1.653 (1.490). These compare with the median IRR of 13% described
in Harris, Jenkinson, and Kaplan (2014) and with the median cash-on-cash multiple of 1.65
reported by Phalippou, Rauch, and Umber (2018), both for sample periods ending earlier.
Summary statistics for the subset of funds with a predecessor fund that is at least 3 years
12
Cochrane (2005), Korteweg and Sorensen (2010) and Jenkinson, Sousa, and Stucke (2013) find that
portfolio companies’ net asset values tend to be higher in fundraising periods. Barber and Yasuda (2017)
further find that funds time their portfolio companies’ strongest exits to coincide with fundraising. Brown,
Gredil, and Kaplan (2018) argue that NAV inflation is practiced by unsuccessful GPs, but that LPs see
through this behavior. Easton, Larocque, and Stevens (2018) find that private equity NAVs more accurately
represent ex post future cash flows following the establishment of ASC 820 (formerly known as SFAS 157),
Fair Value Measurement by the Financial Accounting Standards Board (FASB) in 2008.

10
old appear in columns 5-8 of Table 2. These firms are similar except that they tend to be
slightly larger than the general population of funds, with mean and median fund sizes of
$837.8M and $348.6M. Panel B of Table 2 presents summary statistics partitioned by the
stage of the fund: closed funds that are not yet liquidated, and liquidated funds.
We calculate duration for the funds in our sample. As Panel A of Table 2 shows, mean
(median) duration for our sample is 4.13 (3.99) years whereas mean (median) realized fund
life is 10.13 (10) years. Figure 2 presents a lowess smooth showing that Gap declines mono-
tonically with duration as expected.
To compute the multiple-implied return for a fund, we require an estimate of fund life,
which we do not have for all funds in the sample. For funds that have not yet liquidated, we
use the actual time since the vintage year as the fund’s elapsed life. For liquidated funds,
which typically have a negligible amount of capital left in the fund at the tail end of the
fund’s life, we define fund life as the length of time it takes for investors to receive 95% of
the fund’s total distributions. This is a conservative choice because using the date of the
last distribution as the end of the fund’s life would tend to make the multiple-implied return
smaller, and the gap larger. For some liquidated funds, we do not have fund-level cash flow
data and so we estimate expected fund life by fund type based on liquidated funds from
Preqin’s Cash Flow module. Specifically, we take the median fund life by fund type and use
this in the calculation of the multiple-implied return.13
Table 2 also presents summary statistics on the two measures of return gap (Gap and
13
For each of our regression tests, we separately show results for liquidated funds as it is possible that
results vary for liquidated funds, where we can observe the fund’s IRR over the full life of the fund, and for
non-liquidated funds, where we observe and use the final reported IRR for the fund. Examining liquidated
funds has the advantage that we know the fund’s actual life, whereas examining non-liquidated funds has the
advantage that we do not have to make assumptions about true fund life when there is a negligible amount
of capital left in the fund. Of course, results for liquidated funds may suffer from lack of power, due to the
smaller sample size.

11
MIRRgap). The gaps, multiple-implied return, and IRR are winsorized at the 1% level to
ensure that outliers do not drive our results. The gap for the full sample in Panel A averages
8.43%, more than half of the average IRR, and the median return gap is 5.86%. Figure 3
presents reported IRRs and return gaps by vintage year, and Figure 4 examines IRR and
return gap by type of fund and by investor type. Relative to their multiple-implied returns,
Figure 4 shows that the fund types that tend to have more volatile cash flows, and also more
discretion in the timing of their cash flows, tend to have higher gaps. For example, direct
lending has low average gaps relative to the multiple-implied return of the funds, as the cash
flows to these funds are predictable and are more likely to happen at the beginning and end
of the fund. At the other extreme, turnaround funds can be expected to have very volatile
cash flows with more discretion given to the GP about when to realize them. These funds
have high gaps relative to their multiple-implied returns. Figure 4 Panel B presents gaps by
investor type. These gaps may simply reflect the types of funds that these investors prefer
to invest in but also may reflect skill in choosing funds that have higher durations.
Before beginning our analysis of the persistence of return gaps and of their economic
consequences, we perform a preliminary analysis to compare observed return gaps with
simulated return gaps under some simple assumptions. We simulate cash flows for each
fund by using the fund’s cash-on-cash multiple and simulating cash flows that achieve that
multiple. We assume that all of the fund’s cash calls occur in uniformly distributed amounts
in the first half of the fund life and add up to the total contribution amount. We further
assume that all distributions of cash to investors occur in the last half of fund life, again in
random, uniformly distributed dollar amounts that add up to total distributions.14 We do
14
Metrick and Yasuda (2010) describe how GPs typically invest in new companies only in the first five
years, with some follow-on investments as well as divestitures made in the final five years of a private equity
fund’s life.

12
not assume a distribution of cash flows based on the distributions we observe in our dataset
as we wish to simulate what a fund’s IRR and return gap would look like without any
management of cash flow timing. Results appear in Appendix B. In each of three different
fund size categories (small funds with less than $100M, medium funds with $100-499M, and
large funds with $500M+), we observe that actual return gaps are significantly larger than
simulated return gaps. This suggests that cash calls (distributions) occur later (earlier) on
average than in a random uniform distribution during the first (last) halves of the fund’s
life.

4 Return gap persistence

If return gaps are the result of private equity firms’ individual cash flow timing policies,
we might expect them to persist across funds of a given firm. Alternatively, private equity
firms may learn and change their practices over time, or gaps might be randomly distributed
across firms and funds. In Table 3, we examine whether return gaps from past funds of a
private equity firm are related to return gaps for current funds of the same firm. Thus, this
analysis is restricted to funds that have a predecessor fund that is at least three years older.
In Panel A of Table 3, we examine quartiles of the return gap of the current fund and of
the return gap from the same private equity fund’s latest fund that is at least 3 years older
than the current fund. Quartiles are computed within vintage year and fund type, retaining
only those vintage year and type combinations with at least 4 observations. We test whether
the observed distribution in each of the 16 cells significantly differs from 1/16 = 6.25%, using
two-sided tests. It is apparent that there is more data along the diagonal: lagged gaps in
the top (1st) quartile are associated with subsequent gaps in the top quartile in 7.4% of

13
the sample, which is significantly different from 6.25% at the 1% level. Each on-diagonal
sample proportion is larger than expected, but the difference from 6.25% is not statistically
different from zero. The far off diagonal elements, by contrast, contain proportions that are
sometimes significantly lower than expected. For example, the combination of prior funds
that are in the 4th quartile and current funds in the 1st quartile only occurs in 4.9% of the
sample, which significantly differs from 6.25% at the 1% level.
We note, like Kaplan and Schoar (2005), that these simple tests could be influenced by
overlapping lifespans, and thus overlapping economic fundamentals, during a private equity
firm’s prior and subsequent funds, even though we require funds to be raised three years
apart. We conduct regression analyses in Panels B and C of Table 3. Here, we can control
for fund size. We estimate the following equation where the unit of observation is at the
fund-level:

Gapi = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i (4)

Lagged values indicate the values from the same private equity firm’s lagged fund that was
raised at least three years prior to the current fund i. In this and later tests, we decompose the
lagged fund IRR into the gap, lag3Gap, and the multiple-implied return, lag3MultipleReturn.
In addition, we control for the log of fund size, logFundValue and include 42 fund vintage
and 24 fund type fixed effects. Standard errors are double-clustered by vintage year and by
private equity firm.
Panel B of Table 3 shows that gaps are persistent, suggesting that the distribution of
cash flows along the fund’s life are related to the private equity firm’s management style. In
untabulated regressions, results are stronger if we only require one year’s difference between

14
the current and the lagged fund, no doubt because the data set is larger. Column 4 of Panel
B shows that results are stronger when both current fund IRR and lagged fund IRR are
positive. Recall that a negative IRR results in a negative expected gap, which is not very
meaningful.
Panel C of Table 3 partitions the sample by size of fund, by fund type, and by the location
of the private equity firm. We again restrict the sample to positive IRRs and lagged IRRs.
Power is lower due to the requirement of a lagged fund and the sample split, but we find
that persistence is strongest for medium-sized funds (between $100M and $500M) and for
buyout funds and for liquidated funds. Since the gap is expected to build over the life of the
fund, this latter result is expected. While this observed persistence in gaps across funds of
the same private equity firm is not necessarily due to a deliberate attempt to inflate IRRs,
it may be informative about future funds’ performance.

5 Return gaps and future performance

We next examine whether return gaps are related to future fund performance. High return
gaps might indicate that private equity firms are skilled, both at managing investor percep-
tions about their returns, and at generating economic value for investors. Alternatively, if
a private equity firm expends resources to inflate the fund’s IRR, they may do so at the
expense of the fund’s cash-on-cash multiple.
Table 4 presents regressions of the fund’s multiple-implied return on the earlier fund’s
return gap and control variables, as in the following equation:

M ultipleReturni = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i

15
 This table shows that, after controlling for lagged multiple-implied return and other
controls, for many fund categories there is a negative relation between the return gap of
one private equity fund and the multiple-implied return of the subsequent fund of the same
private equity firm, suggesting that the gap may be an indicator of value destruction to
inflate performance. The results are economically significant. In column 4 of Panel A, the
coefficient of -0.0375 on lag3Gap suggests that, for every one standard deviation (0.110,
from Table 2) increase in the earlier fund’s return gap, the current fund enjoys a 0.4125%
lower multiple-implied return. Column 8 shows that results are strongest when the IRR is
greater than 8%, the sample in which it is unlikely that the investor will be able to find
an alternative investment that yields similar performance. In contrast, the multiple-implied
return is a strong, positive predictor of the next fund’s multiple-implied return, with a
coefficient that is roughly 6 times as large. Panels B and C show that this result is fairly
consistent across subsets of the data. In particular, lag3Gap is negatively associated with
the multiple-implied return of the subsequent fund of the same private equity firm for each
of large funds, venture and other funds, and closed funds.

6 Return gaps and fundraising

While some measure of return gap is an unavoidable part of investing in any asset class
with intermediate cash flows, perhaps investors are able to minimize the effects on their
portfolios by directing investments towards private equity firms with historically lower return
gaps. Private equity investors are commonly considered to be sophisticated investors, and
they could be expected to clearly understand the pitfalls of IRR. In their recent report to
the Norwegian government, Doskeland and Strömberg (2018) point out that though IRR

16
is a flawed measure, they know of no evidence that biases in IRR have an economically
measurable impact on LPs’ investment decisions. However, Phalippou and Gottschalg (2009)
point out that prospective investors are given very little information about past private equity
firm performance when they are deciding between funds. Many investors may only have an
IRRs or an average IRR of the private equity firm’s past funds.

6.1 Probability of raising a subsequent fund

We first test if the return gap of a fund is related to the probability that the same private
equity firm raises a subsequent fund. The dependent variable is an indicator for whether the
private equity firm is able to raise a subsequent fund, and we use a Probit model:

Raisei = α0 + α1 Gapi + α2 M ultipleReturni + Controls + i (5)

In columns 1 through 3 of Table 5, we find that the probability of a private equity firm
raising a subsequent fund is positively associated with each of the IRR, the return gap,
and the multiple-implied return of the earlier fund. However, when we include both the
return gap and the multiple-implied return, the coefficient on Gap is no longer positive
and significant, in the full sample (columns 4 and 5) or in subsamples based on the IRR
(columns 6 through 8). Thus, it appears that the probability that the private equity firm
raises a subsequent fund is unaffected by the return gap on the prior fund.

17
6.2 Size of subsequent funds

Next, we examine the ability of the private equity firm to raise larger funds, conditional on
raising a fund. Table 6 estimates the following equation:

∆Sizei = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i (6)

The dependent variable is the percentage change in size of the current fund from the lagged
fund that was raised at least three years prior. This variable is winsorized at the 1% level
to mitigate the effect of outliers, and funds smaller than $10M are omitted. The regression
also includes 42 vintage and 24 fund type fixed effects, and standard errors are clustered by
vintage year and by private equity firm.
In columns 1 through 3 of Table 6, we find that the size of the private equity firm’s
follow-on fund, conditional on its existence, is positively associated with each of the IRR,
the return gap, and the multiple-implied return of the earlier fund. However, it is important
to consider the effect of both components of IRR, and the following columns of Panel A
include both multiple-implied return and the return gap. In columns 5 and 6, we find no
consistent relation between past multiple-implied return and the size of the private equity
firm’s follow-on fund, but we do find a positive relation between the return gap of the earlier
fund and the increase in size of the subsequent fund. It appears that investors are focusing
on the portion of the IRR that is most difficult for them to realize. For example, in column
(4) of Table 6 Panel A, a return gap that is one percentage point (0.01) larger in the earlier
fund is associated with a subsequent fund that is more than 2.7% larger. In subsets of private
equity funds, Panel B shows that these results are strongest for large funds and for buyout
funds.

18
 We note that our results do not directly compare to those of Brown, Gredil, and Kaplan
(2018), who find that private equity firms inflate interim NAVs during fundraising periods,
especially for liquidated funds. This temporary NAV inflation of active funds may or may
not affect the final IRR that is reported for the fund. Moreover, Phalippou (2011) shows
that a consistent policy of NAV inflation may decrease IRRs.
In these tables, the dependent variable is not a measure of return, so we are also able to
investigate the effect of an alternative breakdown of the IRR into modified IRR (MIRR) and
MIRRgap. The MIRR makes the assumption that any cash flows received by investors are
reinvested in the market portfolio until the end of the fund’s life. Computing MIRR requires
fund cash flows, however, which shrinks our sample. We estimate the following model:

∆Sizei = α0 + α1 lag3M IRRgapi + α2 lag3M IRRi + Controls + i (7)

The results of these regressions appear in Table 6, panels C and D. These tables show very
similar results to those of Panels A and B but with lower power due to the smaller sample
size. This suggests that even if investors compute MIRRs, they still behave as if they invest
based on past IRR.

6.3 Reinvestment decisions at the investor level

We next consider the reinvestment behavior of various types of investors at the investor level.
Early literature suggests that some investor types better process information about private
equity Lerner, Schoar, and Wongsunwai (2007)). However, more recent evidence suggests
that there are not strong differences across investor types, with respect to their performance
(Sensoy, Wang, and Weisbach 2014) and their due diligence and investment activities (Da

19
Rin and Phalippou 2017). Thus, prior literature suggests that all investor types have both
strong and weak investors.
The Preqin Investors module categorizes private equity LP investors across categories
including endowments, public pension plans, and more. We have investor data for 4,432 of
the funds in the sample. This data may not include all investors in each fund, and some
investor-level commitment amounts are missing. We estimate the following equation across
each of the largest investor categories:

Reinvesti,j = α0 + α1 Gapi + α2 M ultipleReturni + Controls + i (8)

In this Probit model, the dependent variable is an indicator variable for whether a given
investor j in private equity fund i invests in a subsequent fund with the same private equity
firm, and the analysis is at the investor-fund level.15 The median investor reinvests with the
same private equity firm 25% of the time during our sample period. We restrict the sample
to funds for which the private equity firm goes on to raise a subsequent fund, and we require
prior funds to be at least three years younger than current funds in order for LPs to be able
to observe performance.
Results for the six largest categories of investor appear in Table 7, Panel A. In this table,
we observe that many of the coefficients on the return gap of the fund are significantly posi-
tive, and none are significantly negative. In particular, funds of funds, insurance companies,
and private pension funds appear more likely to reinvest if the current fund’s gap is higher,
controlling for the multiple-implied return, fund size, and vintage and fund type fixed effects.
For example, given a gap that is 1 percentage point higher, a private pension fund is 0.25%
more likely to invest in the private equity firm’s next fund, holding other variables at their
15
We obtain similar inferences based using OLS regressions.

20
means.
We next conduct an analysis of LP behavior that differentiates LP investors based on
past performance, rather than investor type. Cavagnaro, Sensoy, Wang, and Weisbach (2018)
create a measure of investor skill that is simply the proportion of the investor’s funds that
beat the median IRR for that fund category and vintage. They find that investor type alone
is not a good indicator of skill, i.e. that there are skilled investors of all investor types. Using
Preqin’s fund categories and vintages (for example, large buyout funds of vintage 1995), we
create similar measures of skill which compare the investor’s performance to the median
category IRR in our sample and the median category Multiple in our sample. The first skill
category, “High IRR,” includes investors who invest in at least four funds in our sample, and
whose average indicator variable for beating the median IRR in that category and vintage is
greater than 0.5. Similarly, we categorize investors on whether they tend to beat the Preqin
IRR benchmark, the median fund multiple and the median MIRR (for MIRR, we can only
examine investor performance in the subset of funds for which we have cash flows). The
model we estimate is the same as in Equation 8 except that we create an indicator for each
type of “high skill,” and we add interaction terms for the indicator variable for whether the
investor is “smart” by each of the definitions. Recall that not all investors of a fund appear
in Preqin, and so these measures of skill are relative to only the set of investors who do
appear in the data. To the extent that these investors perform better or worse than the
universe of investors, our results may be biased. Lastly, we require that each fund in this
sample is not the last fund of the private equity firm in our data (through 2017), so that we
can observe whether the investor reinvest.
In these regressions, we include the return gap and the multiple-implied return for the
most recent fund of the private equity firm that is at least three years older than the fund

21
under consideration, their interactions with the skill indicator, and the skill indicator itself.

Reinvesti,j = α0 + α1 Skilled ∗ Gapi + α2 Skilled ∗ M ultipleReturni +

α3 Gapi + α4 M ultipleReturni + α5 Skilled + Controls + i (9)

Results appear in Panel C of Table 7. The coefficients on the interaction terms with skill
indicators show that, when skill is defined by beating the vintage and fund type benchmark
more than 50% of the time, more skilled investors put less weight on the return gap and more
weight on the multiple-implied return when deciding when to invest, though the coefficient
on the interaction term with skill (-0.417) reverses only half of the reliance on the gap (0.882)
for the reinvestment choice. For the other variants of the definitions of skill, this relation
is weaker. For all types, investors regardless of skill put some weight on the return gap
when deciding whether to reinvest. Thus, it does not appear that above-median investors
consistently identify and avoid high-gap funds more than below-median investors.

7 Conclusion

This study examines private equity IRRs and the difference between a fund’s reported IRR
and the annual rate of return implied by the fund’s cash-on-cash multiple, which is not af-
fected by several biases of the IRR calculation. This return gap is persistent across successive
funds of the same private equity firm, suggesting that it stems, in part, from private equity
firms’ choices in the timing of cash flows. We find a negative relation between lagged re-
turn gap and the multiple-implied returns of follow-on funds, however, suggesting that IRR
inflation, intentional or not, is negatively related to private equity firm skill in producing
returns for investors. We further find that return gaps are positively related to the increase

22
in size of the subsequent fund raised by the private equity firm. Moreover, certain investor
types (including insurance companies, private pension funds, and funds of funds) and, by
some measures, relatively less successful investors appear more likely to reinvest with high
return-gap fund managers. By investigating the timing of cash flows throughout a fund’s
life and its relation to reported IRR, we document a limitation of the IRR as a measure of
private equity fund returns as well as the effects on investor choices.

23
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26
 500
400
Number of funds
200 300
100
0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Vintage

Figure 1: Number of funds by vintage year.

27
 .8
.6 .4
Fund Gap
.2 0
−.2

0 5 10 15
Fund duration

Figure 2: Fund gap and fund duration

28
 .5
.4
.3
IRR
.2
.1
0

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Vintage

(mean) IRR (mean) Gap

Figure 3: Reported fund IRR and IRR gap by vintage year.

29
 .14
.12 Turnaround

Secondaries
Venture Debt
Buyout
.1
Mean Gap

Balanced Special Situations

Natural Resources
Expansion / Late
Venture/Early StageStage Growth
.08

Co−investment
Distressed Debt
Mezzanine Real Estate
Infrastructure
.06

Fund of Funds

Direct Lending
.04

.04 .05 .06 .07

Mean multiple−implied return

(a) By fund type

.11

Superannuation Scheme
.1 .09
Mean Gap

Wealth Manager
Investment Company
Family Office
Fund of Funds Manager
.08

Insurance Company Bank

Private Equity Firm

.07

Corporate Investor
Private Pension Fund
Foundation
Endowment Plan
Public Pension Fund

Sovereign Wealth Fund

.06

Government Agency

.03 .035 .04 .045 .05

Mean multiple−implied return

(b) By investor type

Figure 4: Mean return gap and multiple-implied return by fund type and by investor type.

30
 Table 1: Variable definitions

Variable Description Source

Duration Duration of distributions less duration of contributions. Duration of dis- Preqin cash flow mod-
tributions (contributions) calculated as the percentage of contributions ule
(distributions) occurring in any given quarter, multiplied by the quarter
in the funds life, then summed over the funds life.
FundLife The time elapsed from vintage year to 2017 for closed funds that are Preqin cash flow mod-
not yet liquidated, and the time from vintage year to when 95% of cash ule
flows are distributed for liquidated funds.
LogFundValue log of the fund closed value in millions. Preqin
Gap The difference between a fund’s reported IRR and the rate of return im- Preqin
plied by the fund’s multiple as in equation 3. This variable is winsorized
at the 1% level.
IRR The fund’s reported internal rate of return, winsorized at the 1% level. Preqin
lag1- A lagged measure for a fund with a vintage at least 1 year older than Preqin
the current fund. This variable is winsorized at the 1% level.
lag3- A lagged measure for a fund with a vintage at least 3 years older than Preqin
the current fund. This variable is winsorized at the 1% level.
MIRR The fund’s modified internal rate of return, calculated using funds that Preqin
have cash flow data and assuming that money not invested in the fund is
invested in the CRSP total market portfolio. The measure is winsorized
at the 1% level.
Multiple The fund’s reported multiple. Preqin
MultipleReturn The rate of return implied by the fund’s multiple. This variable is Preqin return data
winsorized at the 1% level.
RaiseNextFund Indicator variable for whether the private equity firm raises a future Preqin
fund.
Repeat Investment Indicator variable for whether the fund investment by the investor is a Preqin
repeat with the same GP.

31
 Table 2: Fund-level summary statistics
This table presents summary statistics for the funds in the sample. Panel A summarizes the full sample and the
subsample of funds that have at least one prior fund from the same private equity firm that is at least 3 years
older (This is the sample used in Tables 3, 4 and 6). Panel B breaks the sample into closed funds that are not
yet liquidated, and funds that are liquidated. Variable definitions appear in Table 1. Some variables require cash
flow data to compute, and thus the sample sizes are smaller.

Panel A
(1) (2) (3) (4) (5) (6) (7) (8)
Full sample Has lagged fund
VARIABLES mean p50 sd N mean p50 sd N

32
IRR 0.132 0.111 0.157 6,294 0.131 0.112 0.147 3,480
Multiple 1.653 1.490 0.852 6,294 1.607 1.461 0.765 3,480
MultipleReturn 0.0483 0.0458 0.0540 6,294 0.0503 0.0475 0.0525 3,480
Gap 0.0843 0.0586 0.118 6,294 0.0811 0.0587 0.110 3,480
MIRRgap 0.0376 0.0220 0.111 2,693 0.0420 0.0252 0.108 1,803
FundLife 10.14 10 4.032 2,702 9.726 10 4.039 1,807
Duration 4.129 3.993 1.918 2,702 3.955 3.789 1.860 1,807
FundValue 621.8 250 1,256 6,294 836.4 348.6 1,566 3,480
RaiseFutureFund 0.655 1 0.475 6,294 0.659 1 0.474 3,480
 Panel B
(1) (2) (3) (4) (5) (6) (7) (8)
Closed Liquidated
VARIABLES mean p50 sd N mean p50 sd N

IRR 0.114 0.104 0.124 4,226 0.170 0.135 0.204 2,068

Multiple 1.518 1.430 0.620 4,226 1.929 1.660 1.145 2,068
MultipleReturn 0.0487 0.0451 0.0521 4,226 0.0474 0.0481 0.0575 2,068
Gap 0.0650 0.0523 0.0830 4,226 0.124 0.0817 0.161 2,068
MIRRgap 0.0325 0.0213 0.0907 2,053 0.0539 0.0256 0.158 640
FundLife 9.544 10 4.043 2,060 12.04 12 3.355 642
Duration 3.955 3.774 1.919 2,060 4.688 4.521 1.806 642

33
FundValue 757.1 317.4 1,450 4,226 345.3 150 626.8 2,068
RaiseFutureFund 0.578 1 0.494 4,226 0.811 1 0.391 2,068
 Table 3: Are return gaps persistent across a private equity firms funds?
Panel A presents quartiles of the current and lagged return gap of private equity firms.
Lagged return gap is the return gap for the latest fund that was raised at least three years
prior to the current fund by the same general partner. Quartiles are computed by vintage
and fund type for every vintage and type combination with at least 4 funds. Significance of
the two-sided test of the difference of each proportion from 0.0625 (1/16th), appear as ***,
** and * for 1%, 5% and 10% significance levels.
Panels B and C present the result of regressions for various subsamples of a fund’s return
gap (Gap) on the lagged gap (lag3Gap) and multiple-implied return lag3MultipleReturn),
and fund size (logFundValue). Variable definitions appear in Table 1. Standard errors are
double-clustered by vintage year and by private equity firm. There are 24 fund type and 42
vintage year fixed effects.
Panel A

Current fund gap quartile

1 2 3 4
Prior 1 0.074*** 0.070* 0.061 0.049***
fund 2 0.061 0.068 0.066 0.052***
gap 3 0.068 0.067 0.068 0.055*
quartile 4 0.053** 0.056** 0.063 0.069

34
 Panel B
(1) (2) (3) (4)
Full Full Full IRR &
VARIABLES Sample Sample Sample Lag3IRR>0

lag3Gap 0.0641** 0.0159 0.0185 0.0641*

(0.04) (0.63) (0.57) (0.08)

lag3MultipleReturn 0.204*** 0.201*** 0.103

(0.00) (0.00) (0.23)

logFundValue -0.00273* -0.00488***

(0.07) (0.00)

35
Observations 3,480 3,480 3,480 2,881
R2 0.160 0.164 0.165 0.201
Vintage FE YES YES YES YES
Fund Type FE YES YES YES YES
 Panel C

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Small Medium Large
VARIABLES Funds Funds Funds Venture Buyout Other U.S. Europe Other Closed Liquidated

lag3Gap 0.0906 0.113** 0.00767 0.0807 0.0912* 0.0450 0.0716 -0.0253 0.0759* -0.0178 0.171**
(0.44) (0.05) (0.75) (0.19) (0.09) (0.33) (0.16) (0.66) (0.10) (0.45) (0.01)
lag3MultipleReturn 0.402 0.0748 -0.0220 0.0600 -0.105 0.103 0.0560 0.574*** -0.0623 0.111* 0.183
(0.12) (0.57) (0.86) (0.78) (0.57) (0.32) (0.62) (0.00) (0.73) (0.09) (0.33)
logFundValue 0.0180 -0.00139 0.000358 0.00288 -0.00805** -0.00344** -0.00451*** -0.00565 -0.00499 -0.00186 -0.00532
(0.19) (0.82) (0.89) (0.61) (0.01) (0.05) (0.01) (0.15) (0.35) (0.15) (0.15)

Observations 436 1,289 1,156 371 750 1,760 2,071 587 223 2,189 692
R2 0.316 0.248 0.188 0.549 0.225 0.144 0.220 0.279 0.419 0.114 0.262
Vintage FE YES YES YES YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES YES YES YES

36
 Table 4: Is a fund’s gap related to the GP’s future performance?
This table presents the results of regressions of Mutliple return on the return gap and the multiple-implied return
for the latest fund that was raised at least three years prior to the current fund by the same general partner
(lag3Gap and lag3MultipleReturn), and fund size (logFundValue). Regressions include vintage year and fund type
fixed effects. Variable definitions appear in Table 1. Standard errors are double-clustered by vintage year and by
private equity firm. There are 24 fund type and 42 vintage year fixed effects.
Panel A
(1) (2) (3) (4) (5) (6) (7) (8)
Full Full Full Full Full Lag3 IRR 0 > Lag3 IRR Lag3 IRR
VARIABLES Sample Sample Sample Sample Sample >0 <0.08 >0.08

lag3IRR 0.0290***
(0.00)

37
lag3Gap 0.0217** -0.0375*** -0.0359*** -0.0397*** -0.0271 -0.0421***
(0.05) (0.00) (0.00) (0.00) (0.78) (0.00)
lag3MultipleReturn 0.184*** 0.252*** 0.250*** 0.214*** 0.235 0.199***
(0.00) (0.00) (0.00) (0.00) (0.22) (0.00)
logFundValue -0.00178** -0.00248*** 0.00177 -0.00350***
(0.02) (0.00) (0.36) (0.00)

Observations 3,480 3,480 3,480 3,480 3,480 3,182 690 2,492

R2 0.180 0.175 0.196 0.201 0.202 0.197 0.262 0.206
Vintage FE YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES
 Panel B

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Small Medium Large
VARIABLES Funds Funds Funds Venture Buyout Other US Europe Other Closed Liquidated

lag3Gap -0.0418* -0.0246 -0.0474*** -0.0341* 0.00969 -0.0376*** -0.0434*** -0.0692*** 0.0133 -0.0312*** -0.0259
(0.08) (0.16) (0.00) (0.09) (0.61) (0.00) (0.00) (0.00) (0.67) (0.00) (0.21)
lag3Multiple Return 0.413*** 0.202*** 0.213*** 0.241*** 0.167** 0.235*** 0.247*** 0.380*** 0.0494 0.235*** 0.225***
(0.00) (0.00) (0.00) (0.00) (0.01) (0.00) (0.00) (0.00) (0.68) (0.00) (0.00)
logFundValue 0.00433 -0.00428 0.000325 0.00828*** -0.000863 -0.00329*** -0.00137* -0.00220 -0.000453 -0.00132 -0.00186
(0.31) (0.12) (0.89) (0.00) (0.48) (0.00) (0.10) (0.23) (0.85) (0.15) (0.28)

Observations 540 1,578 1,361 565 871 2,043 2,539 670 270 2,627 852
R2 0.281 0.212 0.248 0.377 0.187 0.199 0.210 0.287 0.261 0.217 0.228
Vintage FE YES YES YES YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES YES YES YES

38
 Table 5: Do higher return gaps help the private equity firm raise a subsequent fund?
This table presents Probit regressions of an indicator for raising a subsequent fund on the return gap and the
multiple-implied return and fund size. Variable definitions appear in Table 1. Standard errors are clustered by
vintage year. There are 24 fund type and 42 vintage year fixed effects.

(1) (2) (3) (4) (5) (6) (7) (8)

Full Full Full Full Full IRR 0 < IRR IRR
VARIABLES Sample Sample Sample Sample Sample >0 <0.08 >0.08

IRR 1.367***
(0.00)

Gap 1.525*** 0.371 0.451 0.332 0.526 0.114

39
(0.00) (0.30) (0.21) (0.35) (0.85) (0.74)

MultipleReturn 4.404*** 3.918*** 4.084*** 4.133*** 6.093** 3.321***

(0.00) (0.00) (0.00) (0.00) (0.04) (0.00)

logFundValue 0.123*** 0.122*** 0.159*** 0.109***

(0.00) (0.00) (0.00) (0.00)

Observations 6,294 6,294 6,294 6,294 6,294 5,494 1,379 4,115

Vintage FE YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES
Pseudo R2 0.291 0.286 0.294 0.294 0.301 0.321 0.284 0.350
 Table 6: Are return gaps related to the size of the private equity firm’s subsequent fund?
This table presents regressions of the percentage change in size of the current fund from the most recent earlier
fund by the same general partner (chsize) on the return gap and the multiple-implied return for the latest
fund that was raised at least three years prior to the current fund by the same general partner (lag3Gap and
lag3MultipleReturn) and fund size (logFundValue).The dependent variable is winsorized at the 1% level. Variable
definitions appear in Table 1. Standard errors are double-clustered by vintage year and by private equity firm.
There are 24 fund type and 42 vintage year fixed effects.
Panel A
(1) (2) (3) (4) (5) (6) (7) (8)
Full Full Full Full Full Lag3 IRR 0 > Lag3 IRR Lag3 IRR
VARIABLES Sample Sample Sample Sample Sample >0 < 0.08 >0.08

40
lag3IRR 2.611***
(0.00)

lag3Gap 3.233*** 2.742*** 2.912*** 3.003*** -12.48 3.410***

(0.00) (0.00) (0.00) (0.00) (0.39) (0.00)

lag3MultipleReturn 7.019*** 2.081 -0.591 1.666 32.85 0.638

(0.00) (0.24) (0.70) (0.21) (0.11) (0.65)

lag3logFundValue -0.812*** -0.769*** -0.909*** -0.731***

(0.00) (0.00) (0.00) (0.00)

Observations 3,480 3,480 3,480 3,480 3,480 3,182 690 2,492

R2 0.103 0.102 0.095 0.103 0.209 0.212 0.302 0.207
Vintage FE YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES
 Panel B

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Small Medium Large
VARIABLES Funds Funds Funds Venture Buyout Other US Europe Other Closed Liquidated

lag3Gap 0.232 1.015*** 3.276*** 2.059** 5.335*** 1.630 3.195*** 0.955 5.894*** 3.204*** 2.180***
(0.59) (0.01) (0.00) (0.04) (0.00) (0.18) (0.00) (0.42) (0.00) (0.00) (0.01)
lag3Multiple Return -0.217 -0.738 -1.628 -1.898 0.0359 1.252 -0.439 2.843 -10.12*** -0.617 1.252
(0.85) (0.53) (0.61) (0.41) (0.99) (0.48) (0.76) (0.23) (0.01) (0.72) (0.72)
lag3logFundValue -0.773*** -1.597*** -1.766*** -0.961*** -0.588*** -0.789*** -0.784*** -0.619*** -0.741*** -0.744*** -0.918***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Observations 556 1,647 1,459 599 934 2,129 2,672 703 287 2,801 861
R2 0.554 0.537 0.399 0.347 0.204 0.237 0.226 0.244 0.405 0.234 0.252
Vintage FE YES YES YES YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES YES YES YES

41
 Panel C
(1) (2) (3) (4) (5) (6) (7) (8)
Full Full Full Full Full Lag3 IRR 0 > Lag3 IRR Lag3 IRR
VARIABLES Sample Sample Sample Sample Sample >0 <0.08 >0.08

lag3IRR 2.611***
(0.00)
lag3MIRRgap 1.044** 0.757 1.314*** 1.944*** 8.424* 1.624***
(0.05) (0.14) (0.01) (0.00) (0.08) (0.00)
lag3MIRR 2.786* 1.482 0.0818 -1.241 2.798 -3.474
(0.09) (0.33) (0.96) (0.53) (0.67) (0.25)
lag3logFundValue -1.006*** -0.867*** -0.904*** -0.862***
(0.00) (0.00) (0.00) (0.00)

Observations 3,480 1,649 1,649 1,649 1,649 1,481 337 1,144

R2 0.103 0.088 0.087 0.088 0.227 0.211 0.324 0.209
Vintage FE YES YES YES YES YES YES YES YES

42
Fund Type FE YES YES YES YES YES YES YES YES
 Panel D

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Small Medium Large
VARIABLES Funds Funds Funds Venture Buyout Other US Europe Other Closed Liquidated

lag3MIRRgap -1.651* -0.597 2.076** 0.681 6.145*** -0.745 1.419 -0.298 11.14 1.696* -1.057
(0.09) (0.21) (0.04) (0.58) (0.01) (0.47) (0.11) (0.92) (0.26) (0.09) (0.19)
lag3MIRR 1.567 -0.669 -0.858 -0.898 -0.144 0.747 0.106 4.413* -1.085 -0.185 7.967
(0.38) (0.67) (0.67) (0.78) (0.98) (0.67) (0.95) (0.09) (0.94) (0.89) (0.12)
lag3logFundValue -0.397*** -1.383*** -1.507*** -1.518*** -0.685*** -0.906*** -0.907*** -0.612*** -1.104*** -0.866*** -1.200***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Observations 119 740 955 299 523 992 1,523 219 72 1,508 306
R2 0.613 0.509 0.333 0.407 0.173 0.269 0.218 0.533 0.398 0.224 0.332
Vintage FE YES YES YES YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES YES YES YES

43
 Table 7: Determinants of investors’ repeat investments with the same private equity firm
This table presents the results of Probit regressions of the likelihood that a private equity investor will invest
with the PE firm again in the future. The dependent variable, Reinvest, is an indicator variable for whether a
given investor j in private equity fund i invests in a subsequent fund with the same GP at least 3 years after the
vintage of the current fund. Thus, the unit of observation is at the LP-fund level. In Panels A and B, investors are
divided by category. In Panel C, skilled investors are those which, throughout our sample have fund investments
that have beat the median IRR, Preqin IRR benchmark, median Multiple, or median MIRR for that category and
vintage more than half of the time. There are 24 fund type and 42 vintage year fixed effects.Variable definitions
appear in Table 1. Standard errors are double-clustered by vintage year and by private equity firm.
Panel A

(1) (2) (3) (4) (5) (6)

VARIABLES Endowment Plan Foundation Fund of Funds Manager Insurance Company Private Pension Fund Public Pension Fund

44
Gap 1.311** 0.883*** 0.649** 0.214 0.625** 0.187
(0.03) (0.01) (0.03) (0.50) (0.02) (0.53)
MultipleReturn -1.219 0.264 2.688*** 3.199*** 2.026** 3.335***
(0.34) (0.79) (0.00) (0.00) (0.03) (0.00)
logFundValue -0.136*** -0.0179 -0.00553 -0.0657** 0.0145 0.0455
(0.00) (0.55) (0.89) (0.02) (0.67) (0.15)

Observations 3,415 5,506 6,269 3,812 7,951 12,342

Vintage FE YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES
Pseudo R2 0.132 0.0925 0.113 0.0796 0.0967 0.108
 Panel B
(1) (2) (3) (4) (5) (6)
VARIABLES Endowment Plan Foundation Fund of Funds Manager Insurance Company Private Pension Fund Public Pension Fund

MIRRgap 0.759 1.022*** 0.972* 0.421 0.788** 0.448

(0.27) (0.01) (0.09) (0.39) (0.03) (0.24)
MIRR -0.492 0.681 2.016 3.496*** 1.667 3.834***
(0.76) (0.68) (0.19) (0.00) (0.28) (0.00)
logFundValue -0.236*** -0.0499 0.0152 -0.0578 -0.0270 -0.0129
(0.00) (0.17) (0.76) (0.15) (0.47) (0.71)

Observations 2,401 3,759 4,404 2,467 5,724 9,329

Vintage FE YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES
Pseudo R2 0.126 0.105 0.113 0.0812 0.109 0.114

45
Panel C
(1) (2) (3) (4)
VARIABLES IRR Benchmark Multiple MIRR

HighSkillXGap -0.121 -0.417* -0.243

(0.60) (0.09) (0.22)
HighSkillXMultipleReturn -0.133 0.776* -0.0270
(0.77) (0.10) (0.96)
Gap 0.643*** 0.882*** 0.698***
(0.01) (0.00) (0.01)
MultipleReturn 2.008*** 1.291* 1.919***
(0.00) (0.10) (0.01)
HighSkill 0.128*** 0.172*** 0.109*** 0.171**
(0.00) (0.00) (0.00) (0.02)
logFundValue 0.00423 0.000828 0.00596 -0.0325
(0.87) (0.97) (0.82) (0.26)
HighSkillXMIRRgap 0.0826
(0.82)
HighSkillXMIRR -0.127
(0.88)
MIRRgap 0.618*
(0.07)
MIRR 2.241**
(0.02)

Observations 36,813 36,294 36,689 25,725

Vintage FE YES YES YES YES
Fund Type FE YES YES YES YES
Pseudo R2 0.0871 0.0888 0.0864 0.0924

46
Appendix A.
This Appendix shows a base case set of cash flows typical to a private equity fund that spans
10 years. There are capital calls in years 0-2, no cash flows in intermediate years and cash
distributions in the later years. The lower half of the table shows a hypothetical case of
subscription line financing for the same fund, where the first two capital calls are borrowed
until year 2 at an interest rate of 1% per year. The private equity fund has closed size 100,
ignoring annual management fees. Baseline cash flows for years 0 through 9 are given in the
first line. In the second case with subscription line financing, the cash flows from years 1
and 2 are borrowed until year 3 at the simple interest rate of 1% per year, costing $3 in year
3. Thus, the LP multiple is lower under subscription-line financing, but the reported IRR is
higher and the carry earned by the GP is 14.45 compared to 0.

0 1 2 3 4 5 6 7 8 9
Fund cash flows -50 -50 0 0 0 0 0 0 75 110
LP cash flows -50 -50 0 0 0. 0 0 0 75 110
Fund IRR 7.90%
Fund Multiple 1.85
Carry to GP 0.00
LP IRR 7.90%
LP Multiple 1.85

0 1 2 3 4 5 6 7 8 9
Fund cash flows 0 0 -103 0 0 0 0 0 75 110
LP cash flows 0 0 -103 0 0 0 0 0 75 95.6
Fund IRR 9.30%
Fund Multiple 1.80
Carry to GP 14.45
LP IRR 8.00%
LP Multiple 1.66

47
Appendix B. How do empirical gaps compare to a simulated setting?
A natural gap between reported IRR and the rate of return implied by the fund’s cash-on-
cash multiple arises due to the existence of intermediate cash flows that effectively shorten the
investment horizon. This gap could be due to exogenous cash flow shocks or to investment
decisions by GPs. To the extent that we would expect different optimal investment and
liquidation times for each holding of each fund, we would expect cash flows to be fairly
random across investment and liquidation periods of the fund. In turn, we would expect
the average return gap to be close to an average return gap computed using these random
cash flows. To investigate this possibility, we simulate cash flows for each fund by using the
fund’s cash-on-cash multiple and simulating cash flows that achieve that multiple. For each
fund type (e.g., buyout or turnaround, and etc.), we estimate the median life over all funds
of that type using the cash flow data. We estimate fund life as the time it takes in years
for LPs to receive 95% of the cash flows from the fund. For the simulation, we assume that
all LP investments occur in uniformly distributed amounts in the first half of the fund life
and add up to the total contribution amount. We further assume that all distributions to
LPs occur in the last half of fund life, again in random dollar amounts that add up to total
distributions. For odd fund lives, we assume a zero payout in the middle year. To be clear,
in the simulation we do not assume a distribution of cash flows based on the distributions
we observe in our dataset as we wish to simulate what a fund’s IRR and return gap would
look like without any management of cash flow timing.
Figure A.1 presents a lowess plot of these results, broken down among small funds (less
than $100M) in Figure A.1a, medium funds ($100-499M) in Figure A.1b, and large funds
($500M+) in Figure A.1c.16 Note that expected gaps are negative for negative IRRs because
shortening the horizon over which negative returns are realized makes the IRR more negative.
Figure A.1 shows that for all fund sizes, reported IRRs are close to simulated IRRs for low
multiple-implied returns, and that the two quantities begin to diverge for positive multiple-
implied returns. For all three fund size categories, the divergence seems largest for multiple-
implied returns of roughly 20% per year. For each category, a t-test of the difference between
simulated and true return gaps finds that actual return gaps are significantly larger than
simulated return gaps. This suggests that cash calls occur later on average than in an
assumed, random uniform distribution during the first half of the fund’s life, and/or that
16
See Tetlock (2007) for details of lowess estimation.

48
 1.5
.8
.6

1
.4
.2

.5
0

0
−.2

−.1 0 .1 .2 .3 −.1 0 .1 .2 .3
raw_Multiple_Return raw_Multiple_Return

Actual IRR rawgap Simulated IRR rawgap Actual IRR rawgap Simulated IRR rawgap

(a) Small Funds (b) Medium Funds

.4
.3
.2
.1
0
−.1

−.1 0 .1 .2
raw_Multiple_Return

Actual IRR rawgap Simulated IRR rawgap

(c) Large Funds

Figure A.1: Simulated and actual IRR gaps. Simulated gaps are obtained by using the fund’s
multiple and simulating cash flows that achieve that multiple, where all LP investments
occur in the first half and all payouts to LPs occur in the last half of the fund’s life. Results
are appear for small funds (less than $100M), medium funds ($100-499M), and large funds
($500M+). The horizontal axis is shorter in Figure A.1c because cash-on-cash multiples for
these large funds are smaller in the data.

distributions occur earlier than in an assumed, random uniform distribution in the last half
of the fund’s life.

49