Since the1990s, global investment in private equity has increased from under $10 billion per year to well over $100 billion. Over the same period, there has also been a shift from public markets in major economies like the U.S. and UK. These developments are likely connected by the fact that small and mid-sized companies are staying private longer or never going public, which is largely the result of more private funding being available to late-stage start-ups and growth companies in these economies.
Over the last two decades, another notable trend has been the rise in private equity investment outside the U.S. and UK. In fact, while the share of U.S. and UK private equity investment was over 90 percent of the total in the mid-1990s, it declined to about 70 percent by 2017. The increase in global private equity investments, and the recent leveling off and slight downturn in global public company listings, raise important questions about the development of capital markets globally. Are changes in the preference for private over public ownership in the U.S. and UK part of a global trend? If so, what factors have driven growth in private equity historically and why? Finally, where can we expect to see further change?
In an attempt to answer these questions and to better understand current and future trends in capital formation through private equity, we study the determinants of buyout investments across 61 countries over the period of 1990-2017, using nearly comprehensive country-industry-level data on international private equity activity. Our main results show that macroeconomic conditions, financial development, and regulatory environment all play some role in determining the level of buyout activity at the country level.
For macroeconomic conditions, we find that buyout activity increases more during economic expansions, measured by a declining unemployment rate. This is likely due to higher demand for capital in a growing economy, indicating that private equity provides capital for companies in need. Given this, private equity might be a substitute for public equity and more actively provide growth capital in economies where public markets are not as active. Nevertheless, we find evidence for the opposite: Countries with more stock trading have more buyout activity, suggesting that private equity activity is indeed complementary to public market activity. Similarly, we find private equity activity also complements to credit market activity. Overall, these results indicate that financial market development goes hand in hand with private equity market development.
Next, we explore how the institutional and regulatory environment in a country affects the extent of buyout activity. The law and finance literature has shown the importance of legal factors for the development of financial markets across countries, and we expect them to play a role in private equity market development as well. As private equity transactions typically involve a large transfer of ownership and private contracting, we explore reforms that our sample of countries have adopted over the sample period on investor protection and contract enforcement. We compare how buyout activity changes after regulatory reform across countries that adopted a reform versus those that did not. We find that countries receive more buyout investment following investor protection and contract enforcement reforms. Furthermore, we also study whether the positive effect of the regulatory reforms differs across countries based on the legal conditions there. On the one hand, a country with weak governance may benefit more from the implementation of regulatory reforms; on the other hand, for the reforms to be effective in attracting more buyout capital, a country may need to already have strong governance in place. We find investor protection and contract enforcement reforms are more effective in attracting buyout capital in countries with better regulatory quality, rule of law, and lower corruption, indicating that reforms need to be supported by strong country governance. Additionally, we find that positive association between regulatory reforms and buyout investments is more pronounced in countries with higher levels of education, suggesting that reforms need to be backed not only by a strong regulatory environment but also high-quality human capital.
We also try to understand whether the factors we identify are specific to private equity, i.e. do these factors similarly affect other traditional forms of investment such as foreign direct investment or gross capital formation in a country? Our analysis indicates that private equity investment responds to macro-economic conditions, financial development, and institutional factors relatively more than do other traditional forms of investment.
Finally, we study where our sample countries stand in terms of realized versus predicted buyout capital investment. Based on our predictions, we find countries like China, Argentina, New Zealand, and Indonesia to be below predicted levels of buyout activity and hence expect them to receive more buyout investment in coming years. We find other countries like Poland, Hong Kong, and Qatar to be above predicted levels, suggesting that they are likely saturated with buyout investment as of the end of 2017.
Despite the tremendous increase in global buyout investments over the last two decades, there is a significant lack of systematic studies exploring the country-level drivers of buyout investments. Our study fills that gap by providing the first large-sample evidence on the determinants of global private equity investments. Our findings contribute to our understanding of how capital markets will evolve in developed and developing economies and have some policy implications as well. Policy makers, especially those in developing economies, should focus on improving the institutional and regulatory environment in addition to providing growth potential to attract private capital, which likely would help local companies realize growth opportunities by providing them needed capital along with significant management expertise.
This post comes to us from professors Serdar Aldatmaz at George Mason University and Gregory W. Brown at the University of North Carolina – Chapel Hill and from Asli Demirgüç-Kunt, chief economist, Europe and Central Asia Region, at the World Bank. It is based on their recent paper, “Determinants of International Buyout Investments,” available here.