Are Private Equity Investors Fooled by IRR

Are private equity investors fooled by IRR?
Stephannie Larocque,∗ Sophie Shive,† and Jennifer Sustersic Stevens‡§
October 15, 2020
Abstract
Private equity firms have discretion over the timing of their funds’ capital calls
and distributions, making the popular internal rate of return an incomplete measure of
private equity fund performance. Do investors avoid the textbook pitfalls of IRR when
cash flow timing is partly endogenous? In our comprehensive sample of 6,945 funds,
more than half of the funds’ IRR is attributable to timing, with substantial variation.
The timing component persists across a private equity firm’s funds and negatively
predicts future performance, but facilitates fundraising. Despite this predictability, we
find little evidence that sophisticated investors avoid funds with IRRs most inflated by
timing.
∗
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, Steve Foerster, William Goetzmann, Tim Jenkinson,
Tim Loughran, Ernst Maug, Ludovic Phalippou, Stefan Ruenzi, Paul Schultz, Yannik Schneider, Sara Ain
Tommar, Florin Vasvari, Michael Weisbach, Ayako Yasuda, and Qifei Zhu, as well as conference participants
at the 2019 AIM Investment Conference, the Paris Dauphine 11th Annual Hedge Fund and Private Equity
Conference, and the Glion Annual Private Capital 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.
Electronic copy available at: https://ssrn.com/abstract=3188867

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 with $8 trillion under management as of December
2019, a 18% increase over 2018 on top of a 15% increase in 2017, according to data compiled
by Preqin. A potential driver of this rapid growth is the attractive past returns and the
“target” returns that private equity firms (general partners, or GPs) advertise to prospective
investors (limited partners, or LPs). The internal rate of return (IRR) is the headline measure
of private equity returns and data providers use it to rank funds relative to their peers of
the same vintage year. However, the IRR is also very sensitive to cash flow timing, as many
finance textbooks show.1 We document the effects of cash flow timing on the IRR and the
consequences of these effects for private equity investors.
A key difference between private equity funds and many other assets is that, once the
investor has committed capital, the investor no longer controls the timing of cash flows into
and out of the private equity fund. Funds typically have an investment period of several
years. Private equity firms invest as positive NPV projects reveal themselves and divest when
an exit is attractive or as the fund nears the end of its contractual lifetime. The pursuit of
economic value naturally drives many fund cash flow timing decisions: Jenkinson and Sousa
(2015) show that conditions in the debt and equity markets affect exit choice. Yet private
equity firms also retain a great deal of discretion. For example, Gompers (1996) describes
how younger venture capital firms take their investee companies public earlier than do older
1
See also Phalippou (2008).

firms. LPs must therefore be skilled at investing cash in the periods before and after it is
needed by the private equity fund. The calculation of IRR, however, assumes that capital
committed to the fund earns the IRR throughout the fund’s life regardless of whether the
capital is invested in the fund. In fact, the more skilled the private equity firm is at timing
investments and exits, the more tenuous the assumption that LPs can earn the IRR on their
capital while it is outside the fund.
Other popular measures of private equity performance include the cash-on-cash multiple
and the public market equivalent, or PME (Kaplan and Schoar, 2005 and Korteweg and
Nagel, 2016). The cash-on-cash multiple, which is the ratio of cash returned to LPs to
the cash that they contribute during the fund’s life, does not account for the length of the
investment period. The PME compares a fund’s returns to those that might have been
earned by placing identically timed cash flows into a market index fund. While this is a
useful comparison, it does not account for the fact that the LP has little discretion over
cash flow timing in the private equity portfolio.2 Moreover, if a private equity fund shortens
the duration of the fund’s cash flows by borrowing to fund an acquisition instead of calling
capital immediately from LPs, PME can be further inflated relative to the index portfolio.3
This study estimates the effects of cash flow timing - whether the result of GP skill at
creating value, early investment exits, fund-level financing, or exogenous market conditions
- on reported IRR, and explores whether private equity investors consider the effects of cash
2
The PME presents a plausible comparison of fund and market portfolios only because the underlying
index is liquid enough to create a parallel portfolio that buys this index at the precise times that the GP
chooses to call capital.
3
Example: Assume that the market earns 10% per year and that a private equity fund has one 3-year,
$100 investment that earns 3× the capital committed. If the fund calls the capital in year 1, it earns a PME
of 300/(100 ∗ 1.13 ) = 2.25. Alternatively, if the fund borrows $100 for one year on behalf of LPs and calls
their capital in year 2, PME is 300/(100 ∗ 1.12 ) = 2.47. In fact, PME can be inflated as long as the fund has
risks unspanned by the market portfolio or the denominator of the PME calculation does not precisely take
into account the effect of time-varying invested capital on the systematic risk of the fund.

flow timing in their fund commitment decisions. Our sample comprises 6,945 private equity
funds from Preqin, nearly half of which have cash flow data, and spans over 40 years. As
evidence of the magnitude of the effect of cash flow timing in our sample, we note that fund
life averages 9.93 years, whereas the duration of fund cash flows averages only 4.04 years.4
Durations also vary widely, with a standard deviation of almost 2 years. Given our sample’s
mean IRR of 12.5%, a 2-year increase in the amount of time that capital is in the fund would
result in an additional 26.6% cash return on capital, with compounding and assuming the
same rate of return.
Our measure of the cash flow timing effect on IRR is simple. We compare a fund’s
reported IRR to the return implied by its cash-on-cash multiple, or “multiple-implied return,”
which offers a benchmark, lower-bound measure of the return to private equity investors over
the entire life of the fund and is largely unaffected by cash flow timing. We call the difference
between the IRR and the multiple-implied return 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.5,6 For robustness, we
also use alternate assumptions such as reinvestment of non-committed funds at the CRSP
4
Duration is used in the sense of the average time that cash remains in the fund, and is calculated as
the undiscounted duration of cash distributions less the undiscounted duration of cash contributions to be
comparable to fund life, and is thus not identical to measures of bond duration.
5
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 measure is
similar in name only. Their measure takes the reported return as the true return to investors and measures a
fund manager’s intra-quarter trading skill; our measure uses the multiple-implied return to compute a lower
bound for the true return to investors.
6
We are not the first to create a measure that incorporates both an IRR and a cash-on-cash multiple. For
example, Renkeema, Goorbergh, and Rivas (2017) devise an estimate of the time-zero IRR of a portfolio of
funds (an IRR that counterfactually assumes that all fund contributions begin at the inception of portfolio,
but which leaves the true fund lives unchanged such that there are multiple distributions) for which the IRRs
and cash-on-cash multiples of the individual funds are known. The purpose of the time-zero IRR is to give
more equal weight to each component fund in the computation of the portfolio average IRR. This method
does not address the GP’s discretion over cash flow timing at the fund-level.

value-weighted market rate of return as in the modified internal rate of return (MIRR), in the
subset of funds for which we have cash flow data, and find similar results. The magnitude,
variation, persistence, and effects of this timing effect have not been documented to date.
We find that the fund types that typically have more volatile cash flows and funds where
the GP has more discretion in the timing of cash flows, such as buyout funds, tend to have
higher return gaps. We then ask whether return gaps in our data are larger than what one
might expect by chance. We simulate uniformly distributed cash flows that would achieve
the cash-on-cash multiple that each fund reports, with contributions occurring in the first
half of the fund’s life and distributions in the second half. We find that when cash-on-cash
multiples are positive, reported IRRs, and thus return gaps, in the data are higher than our
simulation predicts.
Return gaps could persist across the GP’s funds, reflecting differential skill at employing
capital when it earns maximum returns, or at managing IRRs through cash flow timing
choices.7 We find evidence of persistence in the return gap across a GP’s funds, in both
quartile transition probabilities and regression analyses where we control for size, vintage,
and fund type fixed effects. We next ask which fund and private equity firm characteristics
are correlated with the size of fund return gaps. We do not find that the return gap is
related to the presence of fund-level borrowing early in the fund’s life, perhaps because these
subscription-line financing arrangements have only become popular very recently. We find
that return gaps are positively related to the size of hurdle rates of return that private equity
firms pledge to achieve before they can earn carried interest, suggesting that private equity
firm incentives may shape reported IRRs.
7
Kacperczyk, Nieuwerburgh, and Veldkamp (2014) find that market timing ability and security selection
ability of mutual fund managers are related, but mutual fund managers do not control the timing of investor
cash flows to and from their funds.

Return gaps may simply measure GP timing ability and skill at creating value for in-
vestors, and thus be correlated with other measures of return. We investigate the two
components of the IRR as predictors of future returns: first, the multiple-implied return,
which is an annualized measure of the investor’s return during the fund’s life before any prof-
its from reinvesting distributed cash, and second, the return gap, which reflects the effects
of cash-flow timing. We find that the multiple-implied return of a current fund is positively
related to the multiple-implied return of the private equity firm’s subsequent funds but that
the current fund’s return gap is negatively related to future multiple-implied returns. In
the full sample, a one standard deviation increase in the return gap is associated with a
multiple-implied return of the subsequent fund that is 0.58% lower. Moreover, results are
stronger for larger funds and for venture funds. The negative association between a GP’s
return gap in one fund and the performance of future funds suggests that the return gap is
not a measure of GP skill. This illustrates that a policy of basing investment decisions solely
on the IRRs of a private equity firm’s past funds appears to be suboptimal.
Skilled investors may take into account the effects of cash-flow timing on IRRs, especially
if they can observe past funds’ cash-on-cash multiples or cash flow data. Moreover, if limited
partners are able to easily invest committed capital in similar-yielding investments while it
is not in use by the fund, return gaps will not reduce their realized returns, and so we would
not expect the return gap to be related to a private equity firm’s future fundraising ability.
Managers of capital pools that invest in private equity may also be compensated based on
the IRRs that their chosen investments achieve, and thus have little incentive to evaluate
investments by other metrics. We conduct several analyses to determine whether the return
gaps of a private equity firm’s funds affect investors’ investments into subsequent funds.
At the fund level, we find little evidence that a private equity fund’s return gap is pos-

itively related to the probability that the private equity firm raises a subsequent fund, but
strong evidence that it is positively associated with the size of a private equity firm’s follow-
on fund, conditional on it being raised. A return gap that is one percent higher in a private
equity firm’s current fund is associated with a 4% larger size in the private equity firm’s
subsequent fund. In contrast, the current fund’s multiple-implied return is not consistently
associated with the size of the subsequent fund.8
We then examine the reinvestment decisions of the private equity investors that appear
in Preqin. We find that investors are significantly more likely to recommit to a private
equity firm’s next fund if the prior fund has a large return gap, but that the effect of the
multiple-implied return is also significant and three times as large. Building on Cavagnaro,
Sensoy, Wang, and Weisbach (2019), we compute measures of investor skill based on past
performance and find very little evidence that more skilled investors weigh the return gap
less heavily in their decision to reinvest in the GP’s subsequent fund.
Taken together, our results show that private equity investors as a group do not fully
account for the cash flow timing implications of the IRR in their investment decisions and
that their performance by metrics other than the IRR suffers from this. Misallocation of
capital in private equity can have large implications for the pension funds, endowments, and
sovereign wealth funds that make up the bulk of investors, as a one percent per year deviation
in the true return on the capital currently committed would amount to a difference of $74
billion. Our study answers the call by Brown, Harris, Hu, Jenkinson, Kaplan, and Robinson
(2020) for research investigating the effects of delegating investment and exit activity (i.e.,
cash flow timing) on private equity performance.
8
Using the final return gaps of current funds that are not yet liquidated to predict investment in a GP’s
subsequent fund might seem like look-ahead bias. In later analyses, we show that funds’ interim IRRs are
highly correlated with their final IRRs.

2 Private equity background and decomposition of IRR
2.1 Private equity background
Private equity firms manage one or more funds that hold the equity or debt of private
companies. During the fundraising stage, the private equity firm obtains capital commit-
ments from LPs or investors. As investment opportunities arise during the first few years
of the fund’s life, the private equity firm calls the committed capital from the investors. As
the fund matures and divests its portfolio companies, it distributes 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.
A private equity firm’s compensation for managing the fund is tied to the fund’s real-
ized returns.9 Gompers, Kaplan, and Mukharlyamov (2016) show that private equity firms
themselves most often use IRR to evaluate their portfolio company investments. Moreover,
Brown, Gredil, and Kaplan (2019) find that past fund IRRs affect a private equity firm’s
ability to fundraise.
One way to maximize IRR is to shorten the time that the LP’s capital is employed
by the fund by calling the capital from investors as late as possible The private equity
firm can do this flexibly because capital calls typically must be met by LPs with 10 days’
notice.10 To avoid defaulting on capital calls and triggering the consequences laid out in
the LP agreement,11 investors must hold liquid, low-yielding assets. In 2009, the Harvard
9
Compensation typically comprises a 2% management fee on all invested capital and 20% carried interest
(i.e., share of profits) on the total return, sometimes after a hurdle rate of return is achieved. Gompers and
Lerner (1999); Phalippou (2009); Chung, Sensoy, Stern, and Weisbach (2012); and Hochberg, Ljungqvist,
and Vissing-Jørgensen (2014) discuss private equity industry compensation.
10
See Silveira (2019).
11
For example, the LP agreement for Blackstone Fund V dated October 14, 2005, section 3.5, states
that the defaulting partner forfeits voting rights and future capital distributions, and that the interests of
the defaulting partner can be assigned to a substitute limited partner at the rate of 50% of the defaulting

University endowment was forced into fire sales on the secondary 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, in order to be
able to meet its capital calls.12 A fund can also borrow against investor commitments in
order to delay capital calls from investors. The original stated purpose of this subscription
line financing was to render capital calls more predictable for investors (for example, once
per quarter), but LPAs allow for subscription lines to be outstanding for 180 or even 360
days (Silveira, 2019). Appendix A presents an example of the effect on fund-level IRR of
a hypothetical subscription line financing arrangement. In buyout fund data for 2014 to
2018, Albertus and Denes (2019) find a large increase in the use of subscription lines and
that they cause interim fund IRRs to increase by 6.1%, but they only find a 0.7 percentage
point increase in final fund IRRs. Schillinger, Braun, and Cornel (2019) simulate cash flows
from buyout deals and find that the use of subscription lines increases end IRRs by 0.2-0.47
percentage points and decreases fund cash flow durations by 6.5 weeks.
Another way to increase the IRR of a fund is to harvest investments early (e.g., Gompers
1996) or to cause the fund’s portfolio companies to pay large early dividends. Given that
some distributions occur before contributions, private equity funds often never have the
entire committed amount invested at any given point during the fund’s life. An investor
may not be able to immediately reinvest the distributed capital into a new private equity
fund, because it is the second fund’s manager who decides when to call the capital. To avoid
default, it is unwise to commit capital to a second fund that has not yet been returned by
the first fund.
An increasingly sophisticated literature examines risk-return tradeoffs for limited part-
partner’s contributions.
12
See https://harvardmagazine.com/2009/09/sharp-endowment-decline-reported.

ners, and has yet to reach a consensus. Kaplan and Schoar (2005) and Phalippou and
Gottschalg (2009) and Harris, Jenkinson, and Kaplan (2014) find that private equity funds
underperform public markets after fees. Sorensen, Wang, and Yang (2014) find outperfor-
mance but argue that it is inadequate to compensate investors for the risk and illiquidity
associated with private equity investments. 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. These studies do not consider differences across asset classes in the
investor’s cash flow timing discretion. Below, we provide further insight into private equity
returns by decomposing the internal rate of return into a piece that is earned by all investors
while their capital is in the fund, and the remainder of the IRR which is the result of cash
flow timing.
2.2 Decomposition of IRRs
We seek to compare the reported IRR to the rate of return earned by an investor whose
capital is constrained from inception to the end of the fund’s life.13 In the limit, if no return
is earned on the capital outside of the fund, the cash-on-cash multiple measures the return
actually earned by investors over the fund’s life:
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 example, a multiple of 2 would signify a 100% return over the life of the fund, which
13
Cash-on-cash multiples could potentially increase if the fund allows for recycling of capital returned
during the investment period of the fund’s life, but what is relevant for our analysis is how long a given
invested dollar stays in the fund, not how many separate projects it is invested in throughout the fund’s life.
Whether or not recycling is allowed, the cash-on-cash multiple represents the ratio of cash earned in total
by the fund to the cash provided by LP investors.
10

amounts to a 7.2% annualized return for a fund with a ten-year life. We then compute the
difference between the reported IRR and this multiple-implied 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 arise whenever the investment has intermediate cash flows. The return gap
is positive for cash-on-cash multiples greater than one, and negative for multiples less than
one. In the limit, if the duration of the fund’s cash flows equals the life of the fund, the
return gap is zero.
While investors are subject to capital calls and distributions at unknown dates, they can
most likely earn some positive return on the capital while it is outside the fund. While this
measure is potentially more realistic, reinvestment returns should not be too high because
high return, high risk investments might result in loss of principal and missed capital calls.
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. We compute a MIRR 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 an annualized return that an investor
could have earned if she had immediate access to a liquid market index fund for any cash
that was not invested in the private equity fund. This measure requires fund cash flow data
to compute, and is naturally correlated with realized market returns that are partly outside
11

the investor’s control.
3 Data
Our data are from Preqin’s Performance, Fund Summary, Cash Flow, and Investor modules,
downloaded in July and August of 2019. Preqin obtains data through voluntary input from
fund investors and through Freedom of Information Act (FOIA) requests. According to
Preqin, most IRRs are reported to Preqin directly by the GP or an LP source. Preqin
private equity data has been used in a large number of academic studies.14 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 where we can observe both the IRR and cash-on-cash
multiple.
We rely on the Preqin-provided IRR. If a fund is not yet liquidated as of 2019, we require
that it is at least 3 years old and we rely on its latest reported interim IRR and cash-on-cash
multiple. Interim reported IRRs are computed using the assumption that fund-reported net
asset values (NAVs) are terminal values that 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 and this has attracted the attention of both researchers and the SEC.15
Conservatively underreporting NAVs, especially early values, generally boosts the final IRR
14
In just 2017 and later, these include Braun, Jenkinson, and Stoff (2017), Faccio and Hsu (2017), Korteweg
and Sorensen (2017), Barber and Yasuda (2017), Andonov, Hochberg, and Rauh (2018), Phalippou, Rauch,
and Umber (2018), Harris, Jenkinson, Kaplan, and Stucke (2018) and Ang, Chen, Goetzmann, and Phalippou
(2018). Harris, Jenkinson, and Kaplan (2014) compare Preqin data to other data sets.
15
Cochrane (2005), Korteweg and Sorensen (2010), and Jenkinson, Sousa, and Stucke (2013) find that
portfolio companies’ net asset values are 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 (2019) argue that NAV inflation is practiced by unsuccessful GPs, but that LPs see through this
behavior. Easton, Larocque, and Stevens (2020) 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.
12

(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, so it is not clear that interim IRRs should be biased in either direction.
Our sample comprises 6,945 private equity funds with vintages between 1971 and 2015
for which we can observe the fund’s IRR and cash-on-cash multiple. Of these funds, 4,377
are not yet fully liquidated as of 2019, and 2,568 are fully liquidated. Of the 6,945 total
funds, 3,867 funds have a predecessor fund from the same GP with a vintage that is at least
3 years earlier. For some tests that require fund cash flow data, we use a sub-sample of 3,247
funds where this is available, of which 732 are liquidated. Figure 1 shows the total number
of funds in the sample by vintage year.
Summary statistics for the full sample of private equity funds appear in columns 1 to
4 of Table 2. Closed fund value (FundValue) averages $667M with a median of $264M.
Reported average (median) IRR is 12.5% (10.6%), and cash-on-cash multiple (Multiple) is
1.637 (1.471). 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 old appear in columns 5
to 8 of Table 2. These funds tend to be slightly larger than the general population of funds,
with mean and median initial fund values of $904.6M and $368.0M. Columns 9 to 12 present
funds that are liquidated as of 2019. Liquidated funds are less than half as large on average
as funds that have yet to liquidate, illustrating the tremendous growth in the private equity
industry and in fund sizes over the last decade.
Computing the multiple-implied return for a fund requires an estimate of the length of
the fund’s life. For funds that have not yet liquidated, we use the number of years since
13

the vintage year as the fund’s elapsed life. For liquidated funds with cash flow data, we can
observe the realized lifetime for the fund. Funds often have a negligible amount of capital
left undistributed near the end of their lives, so 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
decrease the multiple-implied return and increase the return gap. For funds without cash
flow data, we estimate expected fund life by fund type based on liquidated funds for which
we have cash flows by using the median fund life by fund type. For each of our regression
tests, we separately show results for liquidated funds and funds that have yet to liquidate.
Examining liquidated funds has the advantage that we know the fund’s realized 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.
Table 2 presents summary statistics on Gap and MIRRgap, the two measures of return
gap. The return gap, multiple-implied return, and IRR are winsorized at the 1% level to
ensure that outliers do not drive our results. The return gap for the full sample in Panel A
averages 7.76%, more than half of the average IRR, and the median return gap is 5.69%.
We also calculate the duration of the funds for which we have cash flow data. As Panel
A of Table 2 shows, mean (median) duration for the funds in our sample is 4.0 (3.85) years
whereas mean fund life is 9.91 years with a median of 10 years. Liquidated funds have mean
and median fund lives of 12.05 and 12.0 years. Figure 2 presents a lowess smooth showing
that Gap declines monotonically with duration, as expected.
Figure 3, panel A presents reported IRRs and return gaps by vintage year. As the
preceding paragraphs have described, we use only the latest reported IRRs for non-liquidated
funds and terminal IRRs for liquidated funds. We use only one observation per fund due
14

to the mechanically high autocorrelation of interim IRR over the years of a fund’s life. One
exception is Figure 3, panel B, where we present IRRs and return gaps over the years of the
fund’s life, for the 4,793 funds for which we have quarterly reports from Preqin in at least
3 separate years. This panel shows that IRR is highest on average in years 5, 6, and 7 of
the fund’s life and then the average begins to decrease over later fund years (when the most
successful funds have perhaps already liquidated). The return gap, by contrast, increases
throughout the life of the fund, and the average return gap is at its highest in years 9 and
10. Throughout the analysis, we include vintage year fixed effects, which will absorb this
variation for funds that have not liquidated. The right axis of Panel B of Figure 3 shows
the correlation between the return gap in each year and the final reported return gap of the
fund (excluding the final year, for which the correlation is 1). We can see from this line that
the correlation between the interim and final return gap is always above 0.8 after year 3,
and converges to 1 very quickly. This shows that reported IRRs for funds that are not yet
liquidated as of August 2019 are likely to be very informative about their final IRRs and
return gaps when they do finally liquidate.
Figure 4 examines IRR and return gap by type of fund. The figure shows that the fund
types that tend to have more volatile cash flows, or more discretion in the timing of their
cash flows, tend to have higher return gaps relative to their multiple-implied returns. For
example, real estate funds have low return gaps on average relative to their multiple-implied
returns, 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 have volatile cash
flows with more discretion given to the GP about when to realize them. These funds have
high return gaps relative to their multiple-implied returns. To account for this variation,
we include fund type fixed effects in our fund-by-fund analyses. We also conduct our main
15

analyses on sub-samples that include only venture funds, and only buyout funds.
4 Are return gaps larger than one would expect by
chance?
The return gaps that we observe could simply reflect the economics of the private equity
investment process and may be no higher than we would expect by chance. In this section,
we compare observed return gaps with simulated return gaps under simple assumptions. For
each fund, we use the fund’s cash-on-cash multiple and simulate 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’s 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.16 We do
not assume a distribution of cash flows based on the distributions that we observe in our
dataset as we wish to simulate what a fund’s IRR and return gap would look like without
any purposeful timing of cash flows.
Overall, our simulated return gaps average 0.042 while the actual return gaps average
0.086 and the difference between the two series is statistically significant with a t-statistic
of 17.4 (results untabulated). Figure 5 presents a lowess plot of actual and simulated gaps,
broken down among small funds (less than $100M) in Figure 5a, medium funds ($100-499M)
in Figure 5b, and large funds ($500M+) in Figure 5c.17 Note that expected return gaps are
16
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. See also Kaplan and Schoar (2005).
17
See Tetlock (2007) for details of lowess estimation.
16

negative for negative IRRs because shortening the horizon over which negative returns are
realized makes the IRR more negative. Figure 5 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.
This analysis suggests that cash calls occur later on average than in a uniform distribution
during the first half of the fund’s life, and/or that distributions occur earlier than in a uniform
distribution in the last half of the fund’s life. It also does not appear that the practice of
liquidating the most successful funds early for purely economic reasons (the buyout has
achieved its goals, for example), is driving all of the observed magnitude of the return gap.
While small and medium funds have greater return gaps for higher multiples, this is not true
of large funds. Thus, it is not simply that the successful, high multiple funds that have high
return gaps.
5 What variables explain a fund’s return gap?
5.1 Return gap persistence across a private equity firm’s funds
Return gaps may persist across a firm’s funds, to the extent that return gaps are the result of
a private equity firm’s skill or of its cash flow timing policies, or both. Alternatively, return
gaps might be randomly distributed across firms and funds, driven solely by the timing of
the GP’s identification of positive NPV projects. 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. This analysis is restricted to funds that have a predecessor fund that is at
least three years older.
17

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 firm’s latest fund that is at least three 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 four observations. We test
whether the proportion in each cell of Panel A significantly differs from 1/16, or 6.25%, using
two-sided tests. It is apparent that lagged return gaps in the top (1st) quartile are associated
with subsequent return gaps in the top quartile in 8.4% of the sample, which is significantly
different from 6.25% at the 1% level. The other on- or near-diagonal sample proportions are
larger than expected, but the difference from 6.25% is not always statistically significant.
(If they were, LPs might more easily observe this pattern). 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 5.2% of the sample, which significantly differs from 6.25% at the
1% level. Thus, it seems that high return gaps are the most persistent across funds, while
lower return gaps are less persistent.
Like Kaplan and Schoar (2005), we note that these tests could be influenced by overlap-
ping 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 also would like to control for fund type, size, and vintage. We estimate the following
equation in Panels B and C of Table 3 to control for these factors:
Gapi = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i , (4)
where i indexes the fund and lagged values indicate the values from the same private equity
18

firm’s lagged fund that was raised at least three years prior to the current fund i. We
decompose the lagged fund IRR into its two components, lag3Gap and lag3MultipleReturn.
We control for the log of fund size, logFundValue. We include 42 fund vintage and 24 fund
type fixed effects, and we double-cluster standard errors by vintage year and by private
equity firm here and in later tests.
Panel B of Table 3 provides evidence that return gaps are persistent, suggesting that the
distribution of cash flows throughout the fund’s life is related to the private equity firm’s
management style. Column 4 of Panel B shows that results are stronger when both current
fund IRR and lagged fund IRR are positive. Recall that in the case of a negative IRR, return
gaps are naturally negative and GPs have an incentive to lengthen the investment period
rather than to shorten it.
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 also restrict the sample to positive IRRs and lagged IRRs.
Power is lower due to the sample split, but we find that persistence is strongest for small- and
medium-sized funds (below $100M and between $100M and $499M) and for venture funds.
Panel D replicates the analysis of Panel B using the modified IRR instead of the IRR.
Results are somewhat stronger in Panel D. While this observed persistence in return 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 a private equity firm’s future performance.
5.2 Other correlates of the return gap
Several fund characteristics may be related to the return gap. One possible correlate is
GPs’ use of subscription lines. For 990 of the funds in our sample, Preqin provides a variable
indicating whether the private equity fund self-reports that it uses subscription-line financing
19

(23.6% of responses), that it is permitted to by the LPA but has not used it (1.4%), or that
it does not use it (75%). We combine the latter two categories, but excluding the middle
category does not affect our result. In Table 4, column 1, we include all funds, and have
indicators for each of the reporting funds (UseSLC and NoSLC ). In column 2, we include
only the funds that report, and have one indicator for use of subscription-line financing.
We do not find evidence that the use of subscription lines is related to the return gap
in our sample. This may be because, as Albertus and Denes (2019) find, most of the sub-
scription lines have become active only recently. While they find that only $86.1 million
of subscription-line financing was outstanding in 2014 over 6 funds, $5.3 billion was out-
standing in 2018 at the end of their sample over 72 funds. Another possibility is that use
of lines at the beginning of the fund’s life for short periods of time (as was likely done in
the historical Preqin data) does not affect IRR very much. To investigate this, we calculate
the skewness of distributions and of contributions to the funds for which we have cash flow
data in Appendix B. We find that the skewness (i.e., earliness) of contributions is much less
related to the return gap than is the skewness (i.e., lateness) of distributions.
Another possible correlate of the return gap is the presence of a hurdle rate that the
private equity firm must achieve on the fund prior to collecting any carried interest. We
investigate whether the presence of a hurdle rate and its level are related to the return
gap. Preqin provides a hurdle rate for 289 of the funds in our sample. The hurdle rate
ranges from 5% (1 observation) to a high of 20% (1 observation), with a median of 8%
(60 observations). It is difficult to know whether the observations where the hurdle rate is
missing have a hurdle rate of zero or that simply no information is available. We expect the
presence of a hurdle rate, or a higher hurdle rate, to be positively related to the incentive
to inflate IRR, and this is what we find. Column 3 of Table 4 presents the full sample,
20

with indicator variables for whether the hurdle rate is below 8 percent (HurdleRateLT8 ), at
8 percent (HurdleRateEQ8 ), or above 8 percent (HurdleRateGT8 ). Column 4 restricts the
sample to funds with declared hurdle rates. We find that in both samples, having a hurdle
rate above 8 percent is associated with a higher return gap in the fund. In column 3, having
a hurdle rate that is below 8 percent is associated with a return gap that is 0.05 lower, and
having a hurdle rate above 8 percent is associated with a hurdle rate that is 0.05 higher,
controlling for fund type, size and vintage, and the multiple-implied return. These results
are consistent with the presence of a high hurdle rate being an incentive for private equity
firms to inflate IRR.
Lastly, we examine whether the sequence of the fund in the private equity firm’s lifetime
is relevant to the return gap. On the one hand, we might expect that first-time funds
provide the largest incentive to inflate IRR. On the other hand, cash flow timing may be
a skill that private equity firms learn with experience. While first time funds have higher
raw mean return gaps (0.130 compared to 0.114 in untabulated analysis), this difference is
not statistically significant in column 5 of Table 4 when controlling for vintage and fund
type fixed effects and clustering the standard errors by vintage and private equity firm. In
untabulated results, we find that neither fund number nor log of fund number is a significant
explanatory variable for the return gap.
6 Return gaps and future performance
Are return gaps a marker of skill at both generating economic value and optimizing IRRs,
do they represent resources wasted, or are they unrelated to performance? Answering this
question within a given fund is difficult due to the mechanical correlation of multiple-implied
21

returns with the return gap within the same fund. Thus, we ask if the return gap of a private
equity firm’s prior fund is related to multiple-implied returns of its subsequent fund.
Table 5 presents regressions of the fund’s multiple-implied return on components of the
private equity firm’s lagged fund’s IRR, i.e., the return gap and multiple-implied return, as
well as control variables, as in the following equation:
M ultipleReturni = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (5)
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. This suggests that the return gap may be partially a marker of value destruction to
inflate performance. The results are economically significant. In column 4 of Panel A, the
coefficient of -0.0542 on lag3Gap suggests that, for every one standard deviation (0.107 from
Table 2, column 7) increase in the earlier fund’s return gap, the current fund’s multiple-
implied return is 0.58% lower. Column 7 shows that results are strongest when the IRR is
greater than 8%, the sample in which it is likely that the GP will have met a hurdle rate
(Phalippou, Rauch and Umber, 2018), but also in which it is less likely 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. Panel B shows that this result is fairly consistent across many subsets of the data.
Panel C presents results using the modified IRR rather than the IRR. In this smaller sample,
we find limited evidence that the MIRR gap is related to the multiple-implied return of the
subsequent fund.
22

7 Return gaps and fundraising
Da Rin and Phalippou (2017) find that more than 90% of the LPs who answer their survey
calculate their own measure of past fund performance, and larger LPs are more likely to
conduct sophisticated due diligence, and thus we might expect savvy LPs to discount IRR
in their decision making process. While some level 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. Investors may also manage their investments such that
the cash returned by the funds that they invest in can be quickly reinvested at a similar rate
of return elsewhere. In support of this hypothesis, Doskeland and Strömberg (2018) conclude
that, although IRR is a flawed measure, they know of no evidence that the biases in IRR
have an economically measurable impact on LPs’ investment decisions. However, Phalippou
and Gottschalg (2009) and Barber and Yasuda (2017) point out that prospective investors
are given very little information when they are deciding between funds. Many investors may
only see one or several past IRRs from the private equity firm. Thus, whether investors
correct for the flaws in IRR is an empirical question.
7.1 Probability of raising a subsequent fund
Metrick and Yasuda (2010) and Chung, Sensoy, Stern, and Weisbach (2012) point out that
most of a GP’s compensation may lie in future funds that they are able to raise. Do past
return gaps affect the probability that the private equity firm will raise a future fund? Brown,
Gredil, and Kaplan (2019) find that past fund performance impacts a GP’s fundraising
efforts. We extend this type of analysis by separating the components of IRR, MultipleReturn
23

and Gap. We estimate a probit model, as in Kaplan and Schoar (2005), where the dependent
variable is an indicator for whether the private equity firm is able to raise a subsequent fund:
Raisei = α0 + α1 Gapi + α2 M ultipleReturni + Controls + i . (6)
In columns 1 through 3 of Table 6, we find that the probability that a private equity
firm raises a subsequent fund is positively associated with the IRR of the earlier fund and
each of its components, the return gap and the multiple-implied return. However, when
we include both the return gap and the multiple-implied return, the coefficient on Gap is
roughly one-ninth of the size of the coefficient on the multiple-implied return (column 4).
Thus, it appears that the probability that the private equity firm raises a subsequent fund
is not strongly positively affected by the return gap on the prior fund. Given the size of the
result, for parsimony we do not present subsets of the data.
7.2 Size of subsequent funds
We next examine the ability of the private equity firm to raise a larger amount of capital,
conditional on raising a subsequent fund. Table 7 estimates the following equation:
∆Sizei = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (7)
Following Barber and Yasuda (2017), the dependent variable is the percentage change in size
of the new fund. ∆Size is winsorized at the 1% level to mitigate the effect of outliers.
In columns 1 through 3 of Panel A in Table 7, 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. The following
24

columns of Panel A include both components of IRR, the multiple-implied return and the
return gap. In columns 4, 5, and 6, we find no evidence of a significant 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, in their reinvestment decisions, investors are focusing
on the portion of the IRR that they must realize by their own efforts while the capital is
outside the fund. For example, across the columns of Table 7 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 3-5% larger. In subsets of private equity funds, Panel B shows that these results
are strongest for large funds and for buyout funds.18 We also investigate the effect of an
alternative breakdown of the IRR into modified IRR (MIRR) and MIRRgap in Panel C.
This panel shows very similar results to those of Panel A but with lower power due to the
smaller sample size.
7.3 Reinvestment decisions at the investor level
We next consider reinvestment behavior at the investor level, taking into consideration LP
investor performance, size, and experience with private equity investing. Lerner, Schoar, and
Wongsunwai (2007) suggest that some investor types are more sophisticated than others,
but researchers using more recent data find that there are not strong differences in average
performance across investor types (Sensoy, Wang, and Weisbach, 2014 and Cavagnaro et al.,
2019), nor are there strong differences in due diligence and investment activities (Da Rin and
18
As we have one observation per fund, these results do not directly compare to those of Brown, Gredil,
and Kaplan (2019), 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. Phalippou (2011) shows that a consistent policy of NAV inflation may
decrease IRRs.
25

Phalippou, 2017). Thus, prior literature suggests that all investor types have both strong
and weak investors. We have investor data for 6,205 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 versions of the following equation:
Reinvesti,j = α0 + α1 Skilled ∗ Gapi + α2 Skilled ∗ M ultipleReturni +
α3 Large ∗ Gapi + α4 LargeM ultipleReturni +
α5 Experienced ∗ Gapi + α6 ExperiencedM ultipleReturni +
α7 Gapi + α8 M ultipleReturni +
α9 Skill + α10 Large + α11 Experienced + Controls + i,j . (8)
In this Probit model, the dependent variable is an indicator variable that equals one if a given
investor j in private equity fund i invests in a subsequent fund with the same private equity
firm, and zero otherwise. Thus, the analysis is at the investor-fund level. In untabulated
analysis, we observe that 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. We
include the return gap and the multiple-implied return for the prior fund, as well as indicators
for LP skill, size, and experience both alone and interacted with each of the return gap and
the multiple-implied return.
To measure LP investor skill based on past performance, we follow Cavagnaro, Sensoy,
Wang, and Weisbach (2019) who create a measure of LP skill that is the proportion of the
26

investor’s funds that beat the median IRR for that fund category and vintage. We create
similar measures of skill, the first using the cash-on-cash multiple and the second using the
multiple-implied return of funds that investors have invested in prior to the fund under
consideration (thus, these are backward-looking measures of skill). We compare investor
performance histories only to those of other investors who are also committing capital to a
fund in that vintage year. For each fund-investor pair, we calculate an indicator variable
for whether the investor is in the top half (top 25%) of investors according to cash-on-cash
multiple (Skilled ). We also create an indicator variable for whether the investor is in the top
half (top 25%) of investors according to multiple-implied return in that vintage year.
Next, we measure LP investor experience. Da Rin and Phalippou (2017) show that
investors with a greater absolute capital allocation to private equity tend to spend more effort
on due diligence and monitoring. We thus create an indicator variable, Large, indicating that
the investor is larger than the median investor in the vintage year of the fund. We measure
this by computing the sum of the commitments to funds in which the investor has invested
in the past. Note that these commitment sizes are not always available, so we may miss
some investors who do not report commitment sizes to Preqin.
Lastly, we create an indicator variable for whether the investor has invested in more prior
funds than the median investor as of the vintage year of the fund. We call this indicator
variable Experienced.
Results appear in Panels A and B of Table 8. In both panels, we see that the return gap
of the past fund that the LP investor has invested in is a positive and significant determinant
of the LP’s reinvestment behavior with the GP. The magnitude of the coefficient (0.6 to 0.9,
depending on the specification) is smaller than that of the coefficient on the multiple-implied
return (1.9-5.1), suggesting that the latter is more relevant to these investors. Recall that in
27

Table 7, the lagged multiple-implied return of the prior fund was not related to the size of
the subsequent fund. The first difference between this analysis and that of Table 7 are that,
in Table 8, the investor has invested in the prior fund and thus has first-hand knowledge of
its cash flows, while Table 7 only compares the size of the subsequent fund to the return gap
and multiple-implied return of the prior fund. The second difference is that only a subset of
fund investors are identified in Preqin. Those that are not identified may be more sensitive
to the return gap than they are to the multiple-implied return, and thus drive the strong
results of Table 7. We also find that measures of skill, size, and experience are positively
related to the LP’s decision to reinvest with the same private equity firm.
Coefficients on the interactions of each of the skill, size, and experience variables with
both Gap and MultipleReturn reveal whether investors with these characteristics are more
likely to consider return gaps and multiple-implied-returns when they decide whether to
reinvest with the private equity firm. When skill is measured using the multiple in Panel
A of Table 8, we do not find that investors in the top half of past multiples avoid high
past-return-gap private equity firms any more than investors in the bottom half. We find
some evidence in columns 5 and 6 that investors in the top quartile are less likely to reinvest
with a private equity firm’s next fund if the prior fund that they invested in has a higher
gap. In column 6, the coefficient on Gap is 0.843, and the coefficient on the interaction term
with Skilled is -0.410, suggesting a partial reversal among the most skilled investors. We
also find in column 6 that large and experienced investors overweight the multiple-implied
return in their reinvestment decisions (positive coefficients on the interaction terms of 1.766
and 1.592, respectively). When skill is measured using the multiple-implied return in Panel
B of Table 8, we find no evidence that investors who have performed better in the past are
more likely to avoid subsequent funds of private equity firms when their earlier funds had
28

high return gaps. We do continue to find that large and experienced investors overweight
the multiple-implied return in their decisions. Thus, it seems that the largest and most
experienced investors, but not necessarily those with the highest past multiples or multiple-
implied returns, put more weight on the multiple-implied return than the return gap in
making reinvestment decisions.19
8 Conclusion
We estimate the effects of cash-flow timing - whether the result of GP skill, investment
exits, subscription line financing, or exogenous market conditions - on reported IRRs and
explore to what extent private equity investors consider the effects of cash-flow timing in
their investment decisions.
Focusing on the difference between a fund’s reported IRR and the annualized rate of
return implied by the fund’s cash-on-cash multiple, we find that 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. The negative relation between
a fund’s return gap and the multiple-implied returns of follow-on funds suggests that IRR
inflation is negatively related to private equity firm skill in creating value for investors. We
further find that return gaps are positively related to the increase in size of the subsequent
fund raised by the private equity firm. Contrary to popular academic belief, we find only
limited evidence that sophisticated investors avoid private equity firms whose prior fund
19
In additional, untabulated analyses, we consider whether private equity investors across Preqin-provided
categories including endowments and public pension plans are more likely to reinvest based on the return
gap and the multiple-implied return of the prior fund. Looking across investor types, we observe that some
of the coefficients on the return gap of the prior fund are significantly positive, and none are significantly
negative. This confirms that a broad distribution of investors are influenced by the return gap, and also
confirms prior findings that investor type is a coarse measure of skill. Results are available upon request.
29

IRRs are most inflated by cash-flow timing. These findings have implications for current
private equity investors but are also relevant as the SEC deliberates how best to facilitate
the future entry of 401(k) plans into private equity investing.
30

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500
400
Number of funds
200 100
0 300
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
vintage
Figure 1: Number of funds by vintage year

.6
.4
Fund Gap
.2 0
−.2
0 5 10 15
Fund Duration
Figure 2: Fund gap and fund duration
35

.3 .5
.4
IRR/Gap
.2 .1
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
vintage
Mean IRR Mean Gap
(a) Last reported IRR and gap by vintage year as of 2019
Correlation between gap and last reported gap

0 .01 .02 .03 .04 .05 .06 .07 .08 .09 .1 .11
0 .1 .2 .3 .4 .5 .6 .7 .8 .9 1
IRR/Gap
3 4 5 6 7 8 9 10 11 12 13 14 15
Year of fund life
Mean IRR Mean Gap

Corr(gap, last reported gap)
(b) Intermediate IRRs and gaps by year of the fund’s life
Figure 3: Panel A presents the latest reported values of fund internal rate of return (IRR)
and return gap by vintage year. For liquidated funds, these are final values. Panel B presents
reported IRR and the return gap by year of fund’s life, using historical interim reports. Panel
B also reports the correlation of the return gap in each non-final year with the final return
gap, illustrating that return gaps during the fund’s life are highly informative about final
return gaps for liquidated funds.
36

.14
Turnaround
.12
Mean Gap
Balanced Secondaries
.1
Buyout
Venture/Early Stage Expansion / Late Stage

.08
Growth Co−investment
Natural Resources
Special Situations
Debt
Mezzanine
.06
Real Estate
Infrastructure
Fund of Funds
.03 .04 .05 .06 .07

Mean multiple−implied return
Figure 4: Mean return gap and multiple-implied return by fund type
37

.6
.4
.3
.4
.2
.2
.1
0
0
−.2
−.1
−.1 0 .1 .2 −.1 0 .1 .2
Multiple−implied return Multiple−implied return
Actual IRR gap Simulated IRR gap Actual IRR gap Simulated IRR gap
(a) Small Funds (b) Medium Funds

.3
.2
.1
0
−.1
−.2
−.1 0 .1 .2
Multiple−implied return
Actual IRR gap Simulated IRR gap
(c) Large Funds
Figure 5: Simulated and actual IRR gaps. Simulated return gaps are obtained by using the
fund’s multiple and simulating cash flows that achieve that multiple, where all LP invest-
ments occur in the first half and all payouts to LPs occur in the last half of the fund’s life.
Results appear for small funds (less than $100M), medium funds ($100-499M), and large
funds ($500M+).
38

Table 1: Variable definitions
All underlying data were downloaded from Preqin in July and August 2019. All variables are for the fund-
level data with one observation per fund unless it is specified that they are for the investor-fund level data.
Variable Description
Closed A fund that has not yet liquidated as of 2019.
Duration Duration of distributions less duration of contributions. Duration of distributions (contri-
butions) calculated as the percentage of distributions (contributions) occurring in any given
quarter, multiplied by the quarter in the fund’s life, then summed over the fund’s life. The
total is divided by four such that duration is in years.
Experienced Indicator variable that equals one if an LP investor has invested in more prior funds than
the median investor investing in that year as of the vintage year of the fund, zero otherwise.
FundLife An estimate of fund life for funds for which cash flow data is available. Years elapsed from
vintage year to 2019 for closed funds that are not yet liquidated, and the time from vintage
year to when 95% of cash flows are distributed for liquidated funds. See the variable T for
a broader measure of fund life.
FundNumber The ordering of the fund in the GP’s career according to Preqin.
FundValue Fund closed value in millions. LogFundValue is the log of this value.
Gap The difference between a fund’s reported IRR and the rate of return implied by the fund’s
multiple as in equation 2. This variable is winsorized at the 1% level.
IRR The fund’s reported internal rate of return, winsorized at the 1% level.
HurdleRate The rate of return that the fund must achieve before the private equity firm earns carried
interest.
lag3- A lagged measure for a fund with a vintage at least 3 years older than the current fund.
Large Indicator variable for whether an LP investor is larger than the median investor in the
vintage year of the fund. Size is determined by the cumulative dollars that the investor has
committed to private equity funds in the past, including the current fund.
Liquidated A fund that has distributed all available funds as of 2019.
MIRR The fund’s modified internal rate of return, calculated using funds that 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.
MIRRGap The difference between the MIRR and the multiple-implied return, as in equation 2.
Multiple The fund’s reported multiple, i.e., the ratio of cash distributed to a fund’s investors to cash
contributed into the fund by the investors during the fund’s life.
MultipleReturn The annualized rate of return implied by the fund’s multiple and fund life T. This variable
is winsorized at the 1% level. See equation 1.
Raise Indicator variable for whether the private equity firm sponsoring a given fund raises a future
fund.
RepeatInvestment Indicator variable for whether the LP investor will invest again with the same GP in the
future.
∆Size The percentage change in size of the GP’s subsequent fund.
Skilled Indicator variable for whether an LP investor’s average performance on all past private
equity fund investments places it in the top half (or top 25%) of investors investing in that
vintage year. Performance is measured using the Multiple and the MultipleReturn.
39

Variable Description
T An estimate of fund life in years for all funds. Years elapsed from vintage year to 2019
for closed funds that are not yet liquidated. For funds that have liquidated and have cash
flows, T = FundLife (defined above). For funds that have liquidated and for which cash
flows are not available, we assign the median fund life of fund category measured using the
funds for which we have cash flows.
UseSLC Indicator variable for whether the fund uses subscription line financing. The variable is 1
for funds that indicate that they use it, 0 for funds that indicate that they do not currently
use it, and missing if no data is available.
40

Table 2: Fund-level summary statistics
This table presents summary statistics for the funds in the sample. First, the table summarizes the full
sample, then, 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, 5 and 7). Lastly, the table summarizes the
sample of liquidated funds. Variable definitions appear in Table 1. Some variables require cash flow data to
compute, and thus the sample sizes are smaller.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Full sample Has lagged fund Liquidated
VARIABLES mean p50 sd N mean p50 sd N mean p50 sd N
Duration 4.031 3.846 1.951 3,247 3.888 3.719 1.898 2,198 4.689 4.504 1.817 732
FundLife 9.907 10 4.142 3,247 9.570 9 4.102 2,198 12.05 12 3.360 732
FundNumber 4.121 3 3.092 4,333 5.333 5 3.098 2,525 3.232 2 2.469 1,668
FundValue 667.0 264 1,357 6,945 904.6 368 1,685 3,867 348.3 152.8 594.9 2,568
FutureRaise 0.788 1 0.409 6,945 0.819 1 0.385 3,867 0.824 1 0.381 2,568
Gap 0.0776 0.0569 0.113 6,945 0.0774 0.0591 0.107 3,867 0.104 0.0672 0.147 2,568
HurdleRate 8.135 8 1.255 289 8.111 8 1.187 189 8.215 8 1.576 65
IRR 0.125 0.106 0.154 6,945 0.125 0.108 0.144 3,867 0.157 0.127 0.197 2,568
MIRR 0.0799 0.0813 0.0445 3,247 0.0841 0.0843 0.0416 2,198 0.0664 0.0723 0.0508 732
MIRRgap 0.0231 0.0147 0.101 3,247 0.0279 0.0189 0.100 2,198 0.0451 0.0221 0.138 732
Multiple 1.637 1.471 0.829 6,945 1.615 1.466 0.760 3,867 1.845 1.617 1.070 2,568
MultipleReturn 0.0468 0.0446 0.0555 6,945 0.0480 0.0451 0.0519 3,867 0.0522 0.0531 0.0667 2,568
T 9.788 9.692 3.737 6,945 9.554 9.345 3.829 3,867 10.00 9.692 2.864 2,568
UseSLC 0.236 0 0.425 994 0.282 0 0.450 625 0.0542 0 0.227 240
41

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, 1 being the highest, are computed by vintage
and fund type for every vintage and type combination with at least 4 funds. One sixteenth (0.0625)
is subtracted from each proportion and significance of the two-sided test of the difference of each
difference from zero, 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). Panel C restricts the sample to funds with positive IRRs and lagged IRRs. Panel
D replicates the analysis of panel B with the lagged IRR split into lag3MIRR and lag3MIRRgap
rather than lag3MultipleReturn and lag3Gap. Variable definitions appear in Table 1. Standard
errors are double-clustered by vintage year and by private equity firm. Regressions include 24 fund
type and 42 vintage year fixed effects.
Panel A
Current fund gap quartile

1 2 3 4
Prior 1 0.084*** 0.083*** 0.068 0.054**
fund 2 0.065 0.070 0.056* 0.048***
gap 3 0.061 0.065 0.076 0.059*
quartile 4 0.052*** 0.048*** 0.056* 0.061
42

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

Full Full Full IRR &
VARIABLES Sample Sample Sample Lag3IRR>0 Closed Liquidated
lag3Gap 0.0908*** 0.0512 0.0572* 0.114*** 0.0345 0.0689

(0.00) (0.13) (0.09) (0.00) (0.24) (0.17)
lag3MultipleReturn 0.157** 0.146** 0.0401 0.0693 0.358**
(0.01) (0.02) (0.56) (0.16) (0.01)
logFundValue -0.00360** -0.00668*** -0.00129 -0.00437
(0.05) (0.00) (0.47) (0.25)
Observations 3,867 3,867 3,867 3,177 2,819 1,048

R-squared 0.145 0.148 0.150 0.185 0.065 0.205
Vintage FE YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES
Panel C
(1) (2) (3) (4) (5) (6) (7) (8)

Small Medium Large
VARIABLES Funds Funds Funds Venture Buyout Other U.S. Other
lag3Gap 0.212** 0.125** 0.0492 0.170** 0.119*** 0.0956** 0.135*** 0.0568

(0.01) (0.03) (0.14) (0.02) (0.01) (0.03) (0.00) (0.19)
lag3MultipleReturn -0.217 0.198* 0.0248 -0.0968 -0.119 0.112* 0.0348 0.0466
(0.11) (0.09) (0.74) (0.64) (0.33) (0.09) (0.69) (0.73)
logFundValue 0.0206 -0.000471 -0.00223 0.00133 -0.0118*** -0.00385* -0.00542** -0.00968**
(0.16) (0.94) (0.47) (0.87) (0.00) (0.08) (0.02) (0.01)
Observations 459 1,374 1,344 405 836 1,936 2,355 822

R-squared 0.318 0.235 0.143 0.466 0.215 0.133 0.194 0.246
Vintage FE YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES
43

Panel D
(1) (2) (3) (4) (5)

Full Full Full Full MIRR &
VARIABLES Sample Sample Sample Sample Lag3MIRR>0
lag3MIRRgap 0.129*** 0.105*** 0.105*** 0.109**

(0.00) (0.01) (0.01) (0.01)
lag3MIRR 0.294*** 0.123* 0.123* 0.127
(0.00) (0.08) (0.10) (0.26)
logFundValue -7.65e-06 -0.000646
(1.00) (0.80)
Observations 1,549 1,549 1,549 1,549 1,475

R-squared 0.125 0.117 0.127 0.127 0.128
Vintage FE YES YES YES YES YES
Fund Type FE YES YES YES YES YES
44

Table 4: Other correlates of the return gap
This table regresses the return gap (Gap) on potential fund-level correlates of the return gap. Columns 1 and
2 present indicators for whether the fund uses subscription-line financing. Column 1 uses all observations
including those for which the variable is missing. Column 2 restricts the sample to those funds for which the
variable exists. Columns 3 and 4 explore hurdle rates. Column 3 uses all funds. Column 4 uses only funds
for which the hurdle rate exists. The last column uses indicator variables for the order of the fund in the
GP’s career. Variable definitions appear in Table 1. Standard errors are double-clustered by vintage year
and by private equity firm. Regressions include 24 fund type and 42 vintage year fixed effects.
(1) (2) (3) (4) (5)

VARIABLES Y = Return gap
UseSLC -0.00267 0.00440

(0.55) (0.56)
NoSLC -0.00263
(0.67)
HurdleRateLT8 -0.0499**
(0.03)
HurdleRateEQ8 -2.71e-05 0.0536
(0.99) (0.12)
HurdleRateGT8 0.0499* 0.0886*
(0.06) (0.07)
FirstFund 0.00231
(0.65)
SecondFund -0.00109
(0.75)
ThirdFund -0.00695
(0.17)
MultipleReturn 1.188*** 0.940*** 1.187*** 1.186*** 1.368***
(0.00) (0.00) (0.00) (0.00) (0.00)
logFundValue -0.00110 -0.00396* -0.00103 -0.00464 -0.00121
(0.46) (0.09) (0.50) (0.39) (0.46)
Observations 6,945 994 6,945 289 4,333

R-squared 0.397 0.340 0.398 0.552 0.474
Vintage FE YES YES YES YES YES
Fund Type FE YES YES YES YES YES
45

Table 5: Is a fund’s return gap related to the GP’s future performance?
This table presents the results of regressions of Multiple 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). Variable definitions appear in
Table 1. Standard errors are double-clustered by vintage year and by private equity firm. Regressions
include 24 fund type and 42 vintage year fixed effects.
Panel A
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Full Full Full Full Full Lag3 IRR Lag3 IRR
VARIABLES Sample Sample Sample Sample Sample >0 >0.08 Closed Liquidated
lag3IRR 0.0253***
(0.01)
lag3Gap 0.0126 -0.0542*** -0.0503*** -0.0550*** -0.0556*** -0.0319*** -0.0483**
(0.26) (0.00) (0.00) (0.00) (0.00) (0.01) (0.01)
lag3MultipleReturn 0.182*** 0.265*** 0.258*** 0.240*** 0.208*** 0.185*** 0.322***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
logFundValue -0.00236*** -0.00290*** -0.00349*** -0.00108 -0.00443**
(0.00) (0.00) (0.00) (0.17) (0.03)
Observations 3,867 3,867 3,867 3,867 3,867 3,528 2,736 2,819 1,048
R-squared 0.148 0.143 0.170 0.179 0.181 0.177 0.188 0.183 0.255
Vintage FE YES YES YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES YES YES
Panel B
(1) (2) (3) (4) (5) (6) (7) (8)
Small Medium Large
lag3Gap -0.0423 -0.0507** -0.0380*** -0.0474*** -0.0106 -0.0409*** -0.0536*** -0.0365*

(0.22) (0.02) (0.00) (0.01) (0.54) (0.00) (0.00) (0.08)
lag3MultipleReturn 0.360*** 0.240*** 0.161*** 0.287*** 0.147*** 0.228*** 0.267*** 0.199***
(0.00) (0.00) (0.00) (0.00) (0.01) (0.00) (0.00) (0.01)
logFundValue 0.00824** -0.000858 0.000600 0.00780*** -0.00216 -0.00383*** -0.00155* -0.00387***
(0.04) (0.73) (0.64) (0.00) (0.14) (0.00) (0.06) (0.00)
Observations 564 1,711 1,592 616 959 2,292 2,903 964

R-squared 0.264 0.196 0.197 0.377 0.166 0.176 0.196 0.166
46

Panel C
(1) (2) (3) (4) (5) (6) (7)

VARIABLES Sample Sample Sample Sample Sample >0 >0.08
lag3IRR 0.0263***
(0.00)
lag3MIRRgap 0.0381*** 0.0140 0.0116 0.00245 -0.00260
(0.00) (0.21) (0.32) (0.83) (0.84)
lag3MIRR 0.150*** 0.127*** 0.119*** 0.109*** 0.120***
(0.00) (0.00) (0.00) (0.00) (0.00)
logFundValue 0.00362*** 0.00282*** 0.00155**
(0.00) (0.00) (0.04)
Observations 2,198 1,549 1,549 1,549 1,549 1,403 1,049

R-squared 0.293 0.292 0.300 0.301 0.309 0.304 0.332
Vintage FE YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES
47

Table 6: 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 double-
clustered by vintage year and by private equity firm. Regressions include 24 fund type and 42 vintage year
fixed effects.
(1) (2) (3) (4) (5) (6) (7) (8) (9)

Full Full Full Full Full IRR IRR
IRR 1.715***
(0.00)
Gap 1.861*** 0.481* 0.582** 0.495* -0.216 0.850* 0.516
(0.00) (0.07) (0.02) (0.08) (0.41) (0.07) (0.11)
MultipleReturn 4.982*** 4.444*** 4.819*** 3.498*** 2.079*** 5.708*** 4.111***
(0.00) (0.00) (0.00) (0.00) (0.01) (0.00) (0.00)
logFundValue 0.178*** 0.174*** 0.174*** 0.154*** 0.195***
(0.00) (0.00) (0.00) (0.00) (0.00)
Observations 6,921 6,921 6,921 6,921 6,921 5,975 4,273 4,377 2,542
Pseudo R-squared 0.0904 0.0809 0.0962 0.0969 0.116 0.0983 0.104 0.120 0.124
48

Table 7: 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 (∆Size) 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. Regressions include 24 fund type and 42 vintage year fixed effects.
Panel A
(1) (2) (3) (4) (5) (6) (7) (8) (9)
lag3IRR 3.144***
(0.00)
lag3Gap 4.011*** 3.578*** 4.069*** 4.332*** 4.596*** 4.024*** 3.669***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
lag3MultipleReturn 7.170*** 1.715 -2.093 -1.636 -2.450 -2.510 -1.118
(0.00) (0.27) (0.13) (0.33) (0.26) (0.18) (0.69)
lag3logFundValue -0.890*** -0.881*** -0.879*** -0.900*** -0.992***
(0.00) (0.00) (0.00) (0.00) (0.00)
Observations 3,867 3,867 3,867 3,867 3,867 3,528 2,736 2,819 1,048
R-squared 0.096 0.096 0.085 0.096 0.211 0.212 0.211 0.231 0.240
Panel B
(1) (2) (3) (4) (5) (6) (7) (8)
Small Medium Large
lag3Gap 0.557 1.237** 4.040*** 1.008 4.311*** 5.370*** 3.659*** 5.026***

(0.19) (0.04) (0.00) (0.23) (0.00) (0.00) (0.00) (0.00)
lag3MultipleReturn 0.0877 0.209 -4.588* 1.417 -3.140 -3.013* -1.536 -2.950
(0.91) (0.88) (0.06) (0.47) (0.34) (0.09) (0.33) (0.29)
lag3logFundValue -0.767*** -1.628*** -2.215*** -0.917*** -0.751*** -0.955*** -0.919*** -0.835***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Observations 564 1,711 1,592 616 959 2,292 2,903 964

R-squared 0.574 0.538 0.417 0.359 0.174 0.229 0.221 0.226
49

Panel C
(1) (2) (3) (4) (5) (6) (7)

VARIABLES Sample Sample Sample Sample Sample >0 >0.08
lag3MIRRgap 1.904*** 1.527** 1.623** 1.850** 1.985*

(0.00) (0.04) (0.01) (0.03) (0.08)
lag3MIRR 4.443*** 4.443*** 1.962 2.533 1.328 -1.537
(0.01) (0.01) (0.34) (0.13) (0.56) (0.61)
lag3logFundValue -0.976*** -0.930*** -0.931***
(0.00) (0.00) (0.00)
Observations 2,045 2,045 2,045 2,045 2,045 1,842 1,378

R-squared 0.083 0.085 0.083 0.086 0.214 0.205 0.208
Vintage FE YES YES YES YES YES YES YES
Fund Type FE YES YES YES YES YES YES YES
50

Table 8: 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 Panel A,
the measure of skill is based on the cash-on-cash multiple, and in Panel B the measure of skill is based on
the multiple-implied return. Variable definitions appear in Table 1. Standard errors are double-clustered by
vintage year and by private equity firm. Regressions include 24 fund type and 42 vintage year fixed effects.
Panel A
(1) (2) (3) (4) (5) (6)

VARIABLES Skill = Multiple P50 Skill = Multiple P75
GapXSkilled -0.140 -0.0420 -0.486*** -0.410**

(0.41) (0.81) (0.00) (0.01)
GapXLarge 0.156 0.129
(0.44) (0.53)
GapXExperienced -0.256 -0.267
(0.34) (0.31)
MultipleReturnXSkilled -0.685 -0.346 -1.192*** -0.511
(0.11) (0.40) (0.00) (0.22)
MultipleReturnXLarge 1.811*** 1.766***
(0.00) (0.00)
MultipleReturnXExperienced 1.665** 1.592**
(0.02) (0.03)
Gap 0.602** 0.612** 0.698** 0.610** 0.714*** 0.843***
(0.01) (0.05) (0.05) (0.01) (0.01) (0.01)
MultipleReturn 3.734*** 4.078*** 1.977*** 3.768*** 4.152*** 2.064***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Skilled 0.135*** 0.205*** 0.160*** 0.122*** 0.213*** 0.184***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Large 0.325*** 0.239*** 0.328*** 0.246***
(0.00) (0.00) (0.00) (0.00)
Experienced 0.227*** 0.173*** 0.237*** 0.186***
(0.00) (0.00) (0.00) (0.00)
logFundValue 0.106*** 0.102*** 0.106*** 0.108*** 0.104*** 0.107***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Observations 68,629 68,629 68,629 68,654 68,654 68,654

Pseudo R-squared 0.0983 0.0784 0.0998 0.0977 0.0773 0.0994
51

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

VARIABLES Skill = MultipleReturn P50 Skill = MultipleReturn P75
GapXSkilled 0.499* 0.514** -0.178 -0.198

(0.05) (0.03) (0.20) (0.18)
GapXLarge 0.230 0.148
(0.26) (0.47)
GapXExperienced -0.268 -0.299
(0.29) (0.26)
MultipleReturnXSkilled -3.421*** -2.035*** -2.139*** -0.743*
(0.00) (0.00) (0.00) (0.07)
MultipleReturnXLarge 1.649*** 1.735***
(0.00) (0.00)
MultipleReturnXExperienced 1.698** 1.596**
(0.02) (0.03)
Gap 0.617** 0.395 0.466 0.620** 0.621** 0.783**
(0.01) (0.11) (0.14) (0.01) (0.02) (0.02)
MultipleReturn 3.740*** 5.084*** 2.618*** 3.757*** 4.402*** 2.095***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Skilled 0.111*** 0.183*** 0.170*** 0.0960*** 0.157*** 0.156***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Large 0.330*** 0.243*** 0.331*** 0.249***
(0.00) (0.00) (0.00) (0.00)
Experienced 0.241*** 0.183*** 0.245*** 0.196***
(0.00) (0.00) (0.00) (0.00)
logFundValue 0.108*** 0.102*** 0.106*** 0.109*** 0.104*** 0.108***
(0.00) (0.00) (0.00) (0.00) (0.00) (0.00)
Observations 68,520 68,520 68,520 68,654 68,654 68,654

Pseudo R-squared 0.0974 0.0775 0.0994 0.0972 0.0764 0.0988
52

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
53

Appendix B. Cash flow timing and the gap
Cash contributed later in the life of the fund and cash distributed earlier in the life of the
fund increase the fund’s IRR. In order to confirm that return gaps truly reflect a shortening of
the investment period and contribute to an increased IRR in our sample, we test the association
between a fund’s return gap and the relative timing of its cash flows. For liquidated funds with
cash flow data, we compute a measure of the timing of capital calls and of capital distributions and
relate these to the return gap. For every year in the life of each fund, we calculate the percentage
of total cash contributions and percentage of total cash distributions attributable to that fund
year. Specifically, we divide the cash contributions (distributions) per fund year by the total cash
contributions (distributions) realized from inception to liquidation. These fund-year percentages
provide a fund-specific distribution of cash contributions and distributions throughout the life of
the fund. We then calculate a measure of cash inflow deferral (related to contributions) and a
measure of cash outflow acceleration (related to distributions) by applying a weight to each fund-
year percentage. For contributions, we weight the fund-year percentage by the fraction of the year
in the fund’s life divided by the total fund life, thus weighting later cash inflows more. We sum
these over the life of the fund to arrive at ContSkew, the measure of cash inflow deferral. For
distributions, we exactly reverse the weights over the life of the fund and multiply each fund-year
percentage by the fraction of the fund life minus the fund-year plus one divided by the total fund
life, thus weighting earlier cash outflows more. We sum these over the life of the fund to arrive at
the measure of cash outflow acceleration, DistSkew. Equations 9 and 10 provide more detail:
T
" #
X Contt t
ContSkew = PT · (9)
t=1 Contt
T
t=1
T
" #
X Distt (T − t) + 1
DistSkew = PT · (10)
t=1 Distt
T
t=1
In Table A.1, we find that both measures are positively related to the gap and that the coef-
ficients on DistSkew are larger than ContSkew, and moreover the mean and standard deviations
are twice as large for DistSkew in Panel A. Thus, while our results suggest later capital calls and
earlier distributions are associated with a higher return gap, earlier distributions appear to be most
strongly associated with return gaps.
54

Table A.1: Measures of cash flow skew and the return gap
This table presents summary statistics in Panel A and the result of regressions of the return
gap (Gap) on the relative timing of fund cash flows for the liquidated private equity funds in
our sample that have cash flows in Panel B. Standard errors are double-clustered by vintage
year and by private equity firm. Regressions include 24 fund type and 42 vintage year fixed
effects.
Panel A
(1) (2) (3) (4)

Full sample
VARIABLES mean p50 sd N
ContSkew 0.235 0.227 0.0873 732

DistSkew 0.507 0.517 0.145 732
Panel B
(1) (2) (3) (4)

Full Full Full IRR
VARIABLES Sample Sample Sample >0
ContSkew -0.0682 0.300*** 0.438***

(0.44) (0.00) (0.00)
DistSkew 0.385*** 0.463*** 0.527***
(0.00) (0.00) (0.00)
Observations 732 732 732 566

R-squared 0.139 0.257 0.276 0.387
Vintage FE YES YES YES YES
Fund Type FE YES YES YES YES
55

Are Private Equity Investors Fooled by IRR

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Are Private Equity Investors Fooled by IRR

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Are private equity investors fooled by IRR?

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

October 15, 2020

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2.1 Private equity background

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2.2 Decomposition of IRRs

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

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Gap = IRR − MultipleReturn (2)

MIRRgap = IRR − MIRR (3)

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4 Are return gaps larger than one would expect by

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5 What variables explain a fund’s return gap?

5.1 Return gap persistence across a private equity firm’s funds

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

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5.2 Other correlates of the return gap

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6 Return gaps and future performance

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M ultipleReturni = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (5)

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7.1 Probability of raising a subsequent fund

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Raisei = α0 + α1 Gapi + α2 M ultipleReturni + Controls + i . (6)

7.2 Size of subsequent funds

∆Sizei = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (7)

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7.3 Reinvestment decisions at the investor level

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

α3 Large ∗ Gapi + α4 LargeM ultipleReturni +

α5 Experienced ∗ Gapi + α6 ExperiencedM ultipleReturni +

α9 Skill + α10 Large + α11 Experienced + Controls + i,j . (8)

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, Steven N. Kaplan, and Vladimir Mukharlyamov, 2016, What do private equity

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, 2009, Beware of venturing into private equity, Journal of Economic Perspectives

, 2011, Why is the evidence on private equity performance so confusing?, Working

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Silveira, Mark, 2019, Line dance: The rise of subscription

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

M ultipleReturni = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (5)

Raisei = α0 + α1 Gapi + α2 M ultipleReturni + Controls + i . (6)

∆Sizei = α0 + α1 lag3Gapi + α2 lag3M ultipleReturni + Controls + i . (7)

α9 Skill + α10 Large + α11 Experienced + Controls + i,j . (8)

lag3Gap 0.212 0.125 0.0492 0.170 0.119* 0.0956 0.135* 0.0568

lag3MIRRgap 0.129* 0.105* 0.105* 0.109

lag3Gap -0.0423 -0.0507 -0.0380* -0.0474* -0.0106 -0.0409* -0.0536*** -0.0365*

lag3Gap 0.557 1.237 4.040* 1.008 4.311* 5.370* 3.659* 5.026*

lag3MIRRgap 1.904* 1.527 1.623 1.850 1.985*

GapXSkilled -0.140 -0.0420 -0.486* -0.410

ContSkew -0.0682 0.300* 0.438*