If banks don’t provide finance, private equity will?
by
Hidde van Vliet
Supervisor: dr. H. Vrolijk Co-assessor: dr. W. Westerman
International Financial Management Faculty of Economics and Business
Abstract
This study examines the recovery process of the European private equity industry from the 2008 financial crisis, benchmarked against the recovery of bank lending to non-financial corporations. It aims to determine whether private equity has functioned as a substitute for bank lending in the aftermath of the crisis. I have compared the private equity activity, both in the form of buyouts and venture capital, with bank lending activity for 19 European countries from 2009 until 2013. Results only provide a weak signal of possible substitution from bank lending by private equity buyouts. Furthermore, only one variable was found significant in explaining the substitution behavior of private equity. This was the level of GDP, which has a negative relationship with the substitution by venture capital. This study was the first of its kinds by looking at private equity as a substitute for bank loan financing. Therefore, it provides the groundworks for future research in this area.
JEL Classification: G21; G23; G24
Keywords: Private equity; Bank lending; Financial crisis; Buyout; Venture capital; Substitution
1. Introduction
Since the 2008 financial crisis an often heard critique is that banks are tightening their lending policies. Businesses are said to face difficulties funding their operations, whereas up to the crisis this was much less of an issue. Especially smaller firms are said to be the victim of the stricter lending policies. However, are these complaints legitimate? Some studies have shown that lending policies by banks have tightened since the financial crisis (Kwan, 2010; Kaya et al, 2014). But less loans and/or lower lending volumes are a result of both supply and demand factors. Reasons for a decrease on the supply side after the 2008 financial crisis, might have to do with new financial regulations. Monetary institutions enforced these new regulations on banks in order to minimize syncretic risk. By the new Basel III accord banks are obliged to lower their risk weighting. Most often used strategies are deleveraging of the loan portfolio or accumulating higher capital buffers in order to act as safety-nets. Looking at the demand side, during periods of economic downturn households and firms cut spending and investments, which reduces demand for loans.
behind, keeping businesses highly dependent on bank financing (Wehinger, 2012). Alternative investment funds could be one of those substitutes for bank financing. In my study I want to focus on a particular type of alternative investment fund, namely private equity. By investigating if private equity plays a role in substitution for bank loans.
Both bank lending and private equity investments are driven by the economic up- and down turns. And thus, private equity has also been severely affected by the financial crisis and has faced difficult times since. A clear substitution effect where the one thrives when the other ceases (negative relation) is therefore not to be expected. I have constructed the following research question: Did private equity investment activity recovered more strongly from the financial crisis
than bank lending to non-financial corporations, and if so, was it able to partly fill the financing gap left behind by the contracted lending by banks?
For my study I make use of a dataset that I constructed of 19 European countries covering the years 2009 - 2013. I make use of the following variables to conduct several regression analyses: bank lending to non-financial corporations, private equity investments, stock market capitalization, bond market capitalization, GDP, inflation and unemployment. I create a ratio of private equity investments to total funding (both bank loans and private equity investments) in order to compare the rates of recovery of both funding sources. This study is unique because it only looks at private equity as a form of substitution, whereas previous literature mainly looked at bond markets or substitutes in general.
The rest of the paper is organized as follows. Section 2 discusses the relevant existing literature. Section 3 introduces the data and the variables. Section 4 elaborates on the methodology and econometric models. Section 5 reports and discusses the results of the regression analyses. Section 6 concludes.
2. Theoretical background
2.1. Bank lending since crisis
policies. Kwan also found that large and medium-sized banks were more strict in tightening their loan volumes compared to small banks. At the other hand, small banks always charged higher prices.
Gambacorta and Marques-Ibanez (2011) show that new factors, such as changes in banks’ business models and market funding patterns, had modified the monetary transmission mechanism in Europe and in the US prior to the crisis. Furthermore, they find that banks with weaker core capital positions, greater dependence on market funding and on non-interest sources of income restrained their loan supply more heavily during the financial crisis. They made use of a dataset comprised of individual bank information including additional proxies accounting for banks’ risk, banks’ business models and institutional characteristics. Their set includes more than 1,000 banks from the European Union Member states and the US from 1999 until 2009. Additional background literature on bank lending since the financial crisis can be found in the appendix.
Multiple studies have shown that there is large difference in the financing structure of European and US firms. With almost 80% of outstanding liabilities consisting of bank loans European non-financial corporations rely heavily on bank financing. Whereas, for US non-non-financial firms these bank loans are merely 15% of their outstanding liabilities (Kaya et al., 2014)(Appendix figure 2). Also Kramer-Eis et al. (2014) notify that the high dependency of European SME’s on bank financing is a potential structural weakness for their financing. Despite attempts by the ECB to establish a non-bank lending market to support SME financing, smaller companies often fail to benefit from these alternative financial tools and remain dependent on bank loans and credit lines. In a paper by Harjes et al. (2010), written on behalf of the International Monetary Fund regarding Euro Area policies, constrained bank loan supply is mentioned to form a severe problem for the recovery of the euro-area economy. They also mention that bank lending remains the predominant source of external financing for businesses. According to them large firms might escape this bank lending crunch by issuing their own bonds in capital markets. However, other bank dependent firms, in most occasions SMEs, will not be able to access these capital markets and would face binding credit constraints. They expect a significant drag on growth as SMEs account for 60% of the value added and 70% of employment in the euro area.
2.2. Alternatives for financing
alternative sources of funding that were available, even during financial downturn. Becker and Ivashina (2011) investigate this topic by starting to acknowledge that credit is highly pro-cyclical, as less new credit is needed during recessions. So it is unclear whether loan issuance falls during recessions as a result of demand or supply issues. To find out they study firm level data regarding firms’ substitution between bank debt and non-bank debt (public bonds). They have collected firm level data on bonds issuance by US firms between 1990 and 2010. Firms switching from loans to bonds signals contraction in bank credit supply. They find substantial proof of substitution from loans to bonds at times marked by tight lending standards, strained monetary policy, high levels of non-performing loans and loan allowances. Note, their analysis only applied to firms with access to bond markets. Nevertheless, they state that their findings on substitution behavior have strong predictive power for bank borrowing and investments by small, out-of sample firms.
In a similar study Kaya et al. (2014) investigate the substitution from contracting bank loan supply to lush bond markets. They show that since the collapse of Lehman Brothers in 2008, which is considered the starting point of the financial crisis, bank lending in the euro area has contracted sharply. For their research they looked at about 26.000 individual bond issuances by non-financial
corporations in Western Europe and the US between 1999 and 2013 . For comparison they also 1
collected 40.000 loan deals from the same population. They find a statistically significant substitution effect between bank lending and bond issuance. Furthermore, they investigate to which degree the bond market was able to fill the gaps from contracting bank loans. After acknowledging that this is rather difficult as many unknown factors come into play, they arrive at an estimate that the bond market was able to cushion about a third of the credit crunch. The paper concludes with the following (troubling) findings. First, they found a bias for home market focussing. European banks were cutting more severely on foreign client loans. Second point made by Kaya et al. regards the access to bond markets. Only a small selective group of (large) firms has access to debt capital market instruments. Especially small and medium sized enterprises (SMEs) lack the capabilities and resources to access bond markets. So while there is substitution, it does not mean that firms which are denied a loan, are necessarily the same ones who successfully tap into the bond market.
In a research report for Bain & Company, Tran and Ott (2013) look at the financing and growth opportunities of European SMEs. One of their topics is alternative financing options for SMEs, not only because of contracted bank lending but also because high growth firms need to diversify their funding basis or create a mixture of debt and equity. For their research they conducted more than 140 interviews with a broad cross section of stakeholders in six euro area countries: France, Subject of the study is the European market, therefore figures and conclusions regarding the US 1
Ireland, Italy, the Netherlands, Portugal and Spain. Goal of the study is to identify barriers to alternative financing options and suggest (structural) reform solutions to overcome these barriers. According to their interviewees, the supply of finance is not always the main barrier. Quite often a lack of awareness of alternative financing funds such as public funding schemes, equity investors and nascent peer-to-peer lenders are the restraining force. They come to the conclusion that there is an urge for the emergence of an ecosystem that better supports alternative financing sources. They provide a set of solutions for the support of such an ecosystem. These solutions can be split up in the following categories: dealing with regulatory impediments, supporting the emergence of alternative funding, and supporting market liquidity and securitization. A few examples are: providing tax incentives to encourage emergence of a broader investor base in SME funds, improving liquidity and facilitating greater SME access to additional sources funding (e.g. by reconsidering regulations governing secondary debt and equity markets).
In a monthly ECB journal published in July 2014, the various financial instruments used by firms are investigated. The results show that as firms become more mature and larger, their access to external financial sources increases. Their results show that bank lending mainly reduces when firm size increases and not necessarily when a firm becomes more mature. They also mention several supporting solutions to enhance the alternative financing market. These solutions are more or less in line with the action plans suggested by Tran and Ott (2013) mentioned above.
Kraemer-Eis et al (2014) focus on the need for alternative or additional financing channels for SMEs, by looking at the market segment of debt funds. They also note the difficulties that SMEs experience in accessing alternative financing markets, which makes them heavily reliant on bank financing. Moreover, they also state that banks are less willing to supply loans to SMEs due to the difficulties involved in securitizing these loans. As a result, SMEs can be expected to be more affected by changes in bank lending (resulting from deleveraging) than other larger firms.
2.3.1. Alternative investment funds
AIFMD is to create a harmonized regulatory and supervisory framework for alternative investment managers and promote an internal market for their activities. The need for such regulation was driven by a perceived lack of transparency in the alternative investment fund market and the systemic risk that this posed to the financial system (Seretakis, 2013).
When looking at the business activities, private equity is much different from hedge funds. Private equity funds concentrate their investments in illiquid securities, while hedge funds invest in publicly traded securities while pursuing short-term investment strategies. So hedge funds’ core activity is the active trading in financial instruments and their revenue structure is based on annual performance fees (Shadab, 2009a). The majority of private equity investments are made in private companies or public companies, which are then taken off the public market into private ownership, and their returns are only realized at the end of the funds lifetime. Seretakis (2013) separates the activities between the two investment funds in the following way: private equity is focused on value
creation and hedge funds on value finding. While some hedge funds do invest a part of their
money in private equity funds, this is not their core investment strategy. All active investment fund managers (including hedge funds and private equity funds) are evaluated on their skill of picking the right investments. Hedge fund managers have little influence on the actions of the management of the firms in which they invest. This is different in the case of private equity investors, who do manage to influence the management’s actions during their investment period. This is achieved through contractual provisions, such as board seats, veto rights, and numerous contingent control rights (Metrick & Yasuda, 2011). To summarize, what sets private equity apart from other alternative investment funds and hedge funds in particular is the illiquidity of their investment and their active participation in managing the firm invested in.
2.3.2. Types of private equity investment
capital, mezzanine funds, and rescue/turnaround capital. Growth capital is concerned with providing financing to existing firms in an expansionary phase in order to support their growth. Mezzanine funds provide financing to leveraged buyouts in the form of subordinated debt, with equity participation in the form of warrants to subscribe for shares in the borrower. Rescue/ turnaround capital investors invest in troubled firms by purchasing their debt at a discount, after which they use their rights as debt holders to promote a restructuring of the company.
2.3.3. Private equity mechanics
Most private equity firms are organized in the same manner, namely through a partnership or limited liability corporation. To obtain their financing they set up an investment fund in which investors can invest money. These funds are typically set up as closed-end and finite-life partnerships. Closed-end means that once the money is invested in the fund it will only become available to the investor again at the end of the funds life-time and so it is not possible for the investor to withdraw his funds prematurely. These funds have a fixed lifetime, which usually is 10 years and often have the option to be extended with an additional 3 years. In general private equity firms spend 5 years to invest the raised funds in portfolio companies, leaving them 5-8 years to realize a return on their investment. A portfolio firm refers to the firms that private equity firms obtain by investing the fund’s money. The private equity firm will appoint one of its employees as the general manager who is responsible for managing the fund. The investors of the capital are the limited partners of the fund. They will have very little influence on the allocation of the capital after having invested their money, as long as the agreed upon covenants are being honored. Such covenants restrict for example the amount of the fund that can be invested in a single portfolio company, or restrict the amount of debt that is allowed to be taken on in a single investment or on average to the fund’s total capital.
general partner will also invest an amount of equity in the private equity fund. This amount invested by the general partner will be relatively small and mainly helps to align his interests with the limited partners interests (Payne, 2011). The general partner will primarily generate his returns from fees. These fees consist of an annual management fee, commonly 2% of funds actually invested, and a share of the profits made by the fund as a whole of typically 20%. Yet, the latter payment will be subject to a minimum return to the limited partners of usually 8% (Seretakis, 2011). A few examples of large well known private equity firms are Blackstone, KKR and TPG.
2.3.4. Development of private equity industry
Private equity is an American invention from the early 1980s when Kohlberg Kravis Roberts & Co. L.P. (KKR) raised the first ever private equity fund to finance leveraged buyouts. This American financial tool quickly spread across the Atlantic to Europe, where London serves as the financial hub for private equity across the continent. The UK covers 41.37% of the European private equity activity. Other European countries that are active in private equity are respectively France (17.86%), Germany (10.87%), and Sweden (8.83%)(Tudor, 2013).
During these waves of private equity transactions, the activities of private equity firms have somewhat changed. During the first wave, their focus was on the use of high leverage in portfolio firms and the adoption of incentive mechanisms. This helped to reduce interest from profits before taxes and lowered so-called agency costs (Jensen, 1986). The second wave was different from the first one in two ways. First, holding a public company became much less attractive for top executives due to the following developments: increased costs for holding a public company due to the enactment of the Sarbenes-Oxley Act, downward pressure on executive compensation, and the increasing power of stakeholders (Kaplan & Strömberg, 2009). In order to avoid these negative externalities more public firms were taken private. Second, in this new wave private equity firms became more operations-oriented and focused on providing professional guidance (Matthews, Bye & Howland, 2009). Short-term oriented cost-cutting measures that were adopted during the first wave resulted in public resistance towards private equity firms. Therefore, private equity firms changed their role from so-called financial engineers to operational engineers by providing professional managerial guidance to portfolio firms to improve their value and profitability.
As mentioned earlier the alternative investment funds sector, under which private equity falls, was up to the 2008 financial crisis hardly regulated. This changed severely in the aftermath of the financial crisis. In 2010 the Alternative Investment Fund Managers Directive (AIFMD) was adopted. By creating a harmonized European regulatory framework it tries to achieve the following goals: protecting investors in alternative investment funds and tackling systemic risk. Regarding private equity firms this brings the following set of changes. Private equity fund managers are required to become authorized by the competent authorities of their home Member States. Furthermore, fund managers have to comply with modest initial and continuing capital requirements, devise appropriate risk and liquidity management systems, and implement procedures to identify and manage conflicts of interest that could adversely affect the funds managed or their investors. In order to increase the transparency, the AIFMD mandates reporting requirements at both the fund and portfolio firm level. Finally, the AIFMD tries to protect firms against short-term investment strategies. Therefore, fund managers who acquire control of a firm are restricted for two years after the acquisition from facilitating, supporting, voting or instructing in favor of any distribution, capital reduction, share buyback or acquisition of own shares by the portfolio company. Seretakis (2014) provides more background information on these regulations.
private equity as a substitute. First I will present a hypothesis based on background research from previous studies, expert panel reports and newspaper articles. Based on this available literature I expect that private equity investments will recover more strongly from the financial crisis than bank lending to non-financial corporations. I have several reasons to support this hypothesis. First of all, private equity is less restricted by regulation than banks. Bank regulation has become even more strict since the financial crisis and has led banks to tighten their lending (Bridges et al., 2014). Secondly, private equity investing at the bottom of an economic cycle provides much more opportunity for growth than investing during peaks. According to Meyer (2012) private equity firms posses enough dry powder (cash reserves) in the aftermath of the financial crisis to make investments.
3. Description of the data and variables
This section discusses the data selection, gives an overview of the sample and justifies the different (dependent and independent) variables used for the analyses.
3.1. Data selection
The sample of countries considered in this study has been based on the EVCA Yearbook – 2014 European Private Equity Activity. This report is one of the most comprehensive sources for European private equity fundraising, investment and divestment data. My study will focus on the European market, as this market is much more reliant on bank financing compared to the US market as described in the theoretical background. Therefore, contracting bank lending will have more significant impact in the European market.
3.2. Dependent variables
For my research I conduct multiple regression analyses and therefore make use of the following dependent variables.
1. Private equity investments
2. Total funds (total private equity investments + bank lending to non-financial corporations) 3. PE ratio (total private equity investments / Total funds)
4. VC ratio (Total venture capital investments / Total funds) 5. BO ratio (Buyout investments / Total funds)
For the first dependent variable, private equity investments, I have collected data from the EVCA Yearbook. The EVCA Yearbook contains data on funds invested by private equity firms. They setup their data in two ways, on an industry basis and a market basis. I choose the market basis for my study. Market basis data is allocated according to the country in which the investee company is located. Whereas, industry statistics look at the location of the general partner in order to allocate the investment activity to a certain country. Market data put the dependent variable in the perspective of the firm looking for financing opportunities, instead of looking at private equity firms looking for opportunities for investment. I use the total venture capital figure (which includes
seed, start-up and later stage venture), the buyout figure and the total investment figure . I will 2
conduct separate regression analyses for venture capital, buyout and total investments as I expect there might be significant differences between them. Kelly (2010) for instance showed that all three are differently influenced by cyclical and structural factors.
In order to construct the remaining four dependent variables I have collected data on bank lending. Private equity investors normally do not invest in financial firms, therefore I look only at bank loans to non-financial corporations. I have chosen for a long series dataset on credit to the private non-financial sector constructed on behalf of the Bank of International Settlements (BIS,
The total investment figure is not just an aggregate of the other two. Because this figure also 2
2013) . Dembiermont et al. (2013) provides a description of the dataset. This dataset consists of 3
on average 45 years of quarterly data on total credit to the non-financial private sector, for 40 4
countries. The data is split up into two subcategories: household credit and non-financial corporate credit. I take the non-financial corporate credit. However, this number still includes both bank loans and debt securities. In order to mitigate this problem I use the ratio of bank loans to debt securities found by Kaya et al. (2014) for the euro area countries. Furthermore, the BIS dataset reports in local currencies and therefore data for several countries had to be converted into euros. For this I used the euro / local currency exchange rate at year end for the corresponding year.
With the following components: total private equity investment activity, total venture capital investment activity, buyout investment activity, and bank lending to non-financial corporations I construct the dependent variables mentioned above.
3.3. Independent variables
According to Kelly (2010) private equity investment activity is determined by several factors, which he categorizes as cyclical or structural. Cyclical factors are concerned with the state of a country’s economy. Kelly splits up structural factors in: entrepreneurial environment, institutional environment, taxation regimes, labour market, and capital market. For this study I have chosen the following independent variables: stock market capitalization, bond market capitalization, unemployment, GDP and inflation. I will now elaborate on each independent variable.
3.3.1. Stock market capitalization
Stock market capitalization as a percentage of GDP can be used as an indicator for the depth and liquidity of the capital market. This data is collected from the World Bank database. Furthermore, this indicator serves as a proxy for financial depth, the professionalism of the
Another option would have been to use a dataset by Bezemer (2014), who studied the effects of 3
financial development on economic growth. He constructed a dataset that consists of data from the consolidated balance sheets of monetary financial institutions in central bank sources, for 46 countries over the period 1990-2011. On the asset side of these central banks, loans to non-banks are split up into mortgages to households, household consumption credit, credit to financial
businesses and credit to non-financial businesses. This dataset is quite comprehensive and would seem fit for this research. However, as I want to focus on bank lending in the aftermath of the financial crisis, the dataset by Bezemer lags significant data on post crisis years.
financial sector, deal flow and exit opportunities (Groh and Lichtenstein, 2009). This is of importance as companies and entrepreneurs have a choice whether they use debt or equity to finance their operations. Debt can be obtained through banks or the capital market, depending on the accessibility. Kelly (2010) identifies the importance of a deep and liquid capital stock market, based on the following reasons. First of all, a deep capital stock market provides good exit opportunities for private equity investors, enabling them to materialize their investment in the future. A lack of considerable exit opportunities is one of the main concerns limiting private equity investment (NVCA, 2010). An initial public offering (IPO) is in general the most profitable exit route
for a private equity firm. However, Levis (2007) finds that IPOs are not a popular exit strategy . 5
Second, the liquidity of the stock market is also an important proxy for the supply of investment capital. Transaction costs arise due to information asymmetries between the different parties involved. IPOs can lower these transaction costs by reducing information asymmetries, signaling the experience of the general partner to the investee company. Also, successful IPOs can encourage capital providers to invest more capital and at more favorable terms (Schertler, 2003). Thirdly, the availability of leverage, which is one of the key financial tools applied by private equity investors, is signaled by the depth and liquidity of the capital market. Empirical literature by several researchers support these arguments. According to studies by Black and Gilson (1999) and Gompers and Lerner (2000) private equity is more prevalent in countries with deep and liquid stock markets. Schertler (2003) finds that there is a significant positive correlation between the liquidity of the stock market and early stage venture capital investments. Furthermore, Meyer (2006, 2008) finds a positive and significant relationship between the ratio of current IPOs to venture capital investments four years prior and current venture capital investments. According to Meyer this proves that most start-ups need at least a couple of years of business development before they can be sold successfully to the public market. However, Meyer does acknowledge that successful exits in the past can hardly imply any guarantees for successful divestments in the future and refers to the pro-cyclical nature of venture capital investments. Finally, stock market depth, or the market capitalization of listed firms, is found to be a driver of venture capital investment (Clarysse
et al., 2009).
3.3.2. Bond market capitalization
As mentioned in the theoretical background section the bond market could function as a substitute for financing when banks are tightening their lending (Becker and Ivashina, 2011; Kaya
et al., 2014). Therefore, I expect that the bond market will be of importance when estimating the
According to Levis (2007) IPOs only provided an exit for 2.7% of the number of divestments, nevertheless
5
activity in both private equity and bank loans. Bond market capitalization also signals the depth and professionalism of the financial market (Groh and Lichtenstein, 2009). The variable measures the public bond market as a percentage of local GDP. So governmental bonds are not part of this measure. Data is collected from the Global Financial Development Database, provided by the World Bank. However, data was only available for 2009, 2010 and 2011. This would force me to exclude 2012 and 2013 from my analysis if bond market capitalization is used in a regression model. I have run all my test in twofold, both with and without the variable bond market capitalization. In the methodology section I will further elaborate on this matter.
3.3.3. Unemployment
In order to take into account the state of the labour market I use unemployment figures. The rate of unemployment is measured as a percentage of the total labour force and is also retrieved from the World Bank website. Kelly (2010), finds a significant negative relation between unemployment and venture capital investment activity. According to him this supports the consensus that venture capital is more often provided to opportunity-based, instead of necessity-based entrepreneurs. This claim is also supported by Meyer (2008), who finds that those who are entrepreneurs driven by necessity rather than choice, in case of the unemployed for example, are less likely to use venture capital financing.
3.3.4. Cyclical factors
4. Methodology
In this section I provide an overview of the methodology that I have used to conduct my research and shall elaborate on the construction of the regression models.
4.1. Relationship between private equity and bank lending
First, I will test whether there is a (significant) relationship between the amount of bank lending and private equity investments. Determining if such a relationship is present is necessary before I construct a regression model to test my hypothesis. I use the following regression model to estimate the relationship:
PEi,t = αi,t + 𝛽1LENDINGi,t + 𝛽i DUMMYi + 𝜀i,t (1)
I use a log of both the private equity investments (dependent variable) and the bank lending to non-financial corporations (independent variable). Furthermore, I include a dummy variable for all of the sample countries. The reason for including a dummy variable for every country is because there is a great degree of variation in both the private equity investments and the bank lending
between the different countries. The variation was to widespread to create any clusters . 6
From the regression analysis I find a positive relationship between the amount of bank lending and the private equity investments (table 1). The relationship is not significant (0.558), but this does not matter as I’m testing the direction of their movements and not the explanatory power. We know from the literature in the theoretical background that bank loans and private equity are both effected by the economic cycle. The regression model confirms that they would both move in the same direction.
4.2. Testing the explanatory variables
To assess the economic determinants of both private equity and bank lending I create a dependent variable named total funds. This variable is an aggregate of the total private equity investments and the bank lending. For the entire sample of countries the relationship is estimated using the following empirical model:
TOTALi,t = αi,t + 𝛽1STOCKi,t + 𝛽2BONDi,t + 𝛽3UNEMPLOYMENTi,t + 𝛽4GDPi,t + 𝛽5INFLATIONi,t
+ 𝜀i,t (2)
According to the results from the regression analysis in table 2, all the variables except for
inflation seem to play a significant role in estimating the amount of total funds. Stock market
capitalization, bond market capitalization, GDP and unemployment all show a positive relationship
with the dependent variable. The only odd result here is the positive relationship with
unemployment. I would expect a negative relationship instead, as economic prosperity (high degree
of investments and lending) would create demand for jobs resulting in lower unemployment rates.
However, if we look at the standardized coefficient unemployment has the lowest explanatory
power of all the variables. GDP has the highest explanatory power according to the standardized
coefficients (0.878). Followed by stock market capitalization (0.175) and bond market capitalization
(0.155).
TOTALi,t = αi,t + 𝛽1STOCKi,t + 𝛽2BONDi,t + 𝛽3UNEMPLOYMENTi,t + 𝛽4GDPi,t + 𝛽5INFLATIONi,t
+ 𝛽i DUMMYi + 𝜀i,t (3)
The results presented in table 3, are quite different. Only GDP remains highly significant (<0.000) with a high standardized coefficient (0.572). Stock market capitalization and unemployment have switched signs and now show a negative relationship to the dependent variable. Furthermore, it seems that after GDP the largest part of the model is explained by the
differences between countries (the dummy variables) . 7
4.3. Testing the ratios
In order to compare the activity of private equity with bank lending while taking into account the large size difference between both markets I look at the ratio, as mentioned in section 3.2. First I construct the following empirical model to estimate the ratio of private equity investments to the total funds:
PE/TOTALi,t = αi,t + 𝛽1STOCKi,t + 𝛽2UNEMPLOYMENTi,t + 𝛽3GDPi,t + 𝛽4INFLATIONi,t + 𝛽i
DUMMYi + 𝜀i,t (4)
Bond market capitalization has been excluded from this model. Including the bond market capitalization variable would force me to exclude the data for the years 2012 and 2013. I have run a regression test with and without the bond market capitalization variable. Finally, the model without the variable but with additional years of data for the other variables provided more
meaningful results . I do include the dummy variables as in model 3 in order to take into account 8 the aspect of differences between countries. The results are presented in table 4.
Furthermore, I have created two similar empirical models for the ratio of buyouts (BO), and venture capital (VC) to the total funds. As mentioned in the theoretical background section, I have reason to believe that these types of private equity investments behave differently. Their results are presented in table 5 and 6 and will be discussed in section 5.
BO/TOTALi,t = αi,t + 𝛽1STOCKi,t + 𝛽2UNEMPLOYMENTi,t + 𝛽3GDPi,t + 𝛽4INFLATIONi,t + 𝛽i
DUMMYi + 𝜀i,t (5)
VC/TOTALi,t = αi,t + 𝛽1STOCKi,t + 𝛽2UNEMPLOYMENTi,t + 𝛽3GDPi,t + 𝛽4INFLATIONi,t + 𝛽i
DUMMYi + 𝜀i,t (6)
5. Discussion of results
In this section I will present and discuss the results of the regressions analyses. For all the empirical models I have conducted linear regression analysis in SPSS. The results of the first regression analysis have already been discussed in section 4.1 and show that there is a positive relationship between bank lending and private equity investment activity.
coincide with previous literature. Kelly (2010) for example finds a negative relationship for unemployment. In my model unemployment falls just within a 10% significance level. However, the standardized coefficient is rather low (.089) meaning that the variable only explains a small part of the model.
The third model, which takes into account the effect of differences between countries through the usage of dummy variables, reveals much different results compared to the second model. Still the size of the economy, measured by GDP, has the strongest influence. But the other variables have lost their significance and dropped severely in their beta, meaning that their influence has decreased in explaining the dependent variable. The country dummies show that a large part of the variance is explained by the countries being different from each other.
Some explanations why my results do not match those of other literature, especially the results from the third model. First of all, I have investigated a different time period, whereas most previous literature uses data from before the 2008 financial crisis I use data after this period. Second, my time span is rather short due to a lack of available data. The empirical models 2 and 3 both include the bond market variable for which data was only available up till 2011. Resulting in a dataset that covers only 3 years for 19 countries.
Next the results of the ratio regression models will be discussed. Model 4, the private equity to total funds ratio, has a low R-square (.335) and insignificant variables (table 4). Meaning that the variables used for the regression fail to explain the dependent variable. Table 7 provides an overview of the ratios for every country in 2009 and 2013, green highlights increased ratios and red highlights decreased ratios. Darker colors represent more substantial changes. The data on PE ratios shows no clear trend and therefore prohibit from drawing any conclusions. This is consistent with the regression variables, which also fail to be explanatory. Results of the Buyout ratio model are similar, having a low R square (.333) and a lack of significance. Table 7 on the other hand presents other results, the ratio seems to have increased for the majority of countries. Meaning that the amount of private equity buyout investments has grown faster than the bank lending between 2009 and 2013.
From these results we can conclude that in most countries buyout investments have recovered better since the financial crisis than bank lending. However, the recovery of venture capital and private equity overall fluctuates greatly per country. This study has looked only at economic factors that explain the degree of private equity investments and bank lending. These factors fail to explain the variance in recovery behavior since the financial crisis.
6. Conclusion
I examined the recovery process of the European private equity industry from the 2008 financial crisis, benchmarked against bank lending recovery. In order to test if private equity financing functions as a substitute for bank lending to non-financial corporations. Since the financial crisis bank lending has contracted and firms are forced to look for alternative financing options. Previous literature has merely looked at bond or stock markets as substitutes. Therefore, no information is yet available on the role that private equity could play in the European financing market, which historically has been heavily reliant on bank financing.
the change in ratios between 2009 and 2013 shows that buyout investments have recovered more strongly than bank lending for the majority of countries. This indicates that private equity buyouts might have served as a substitute for bank lending. However, more in-depth research is required to prove that this increased buyout activity was due to substitution. The ratios of venture capital and total private equity investments show varying results per country. This makes it difficult to draw a general conclusion for the European area as a whole.
Furthermore, I have tried to explain the substitution behavior (changes in the ratios) with regression analysis. I used several economic indicators for my regressions. I included a measure of the stock- and bond market, which represent the liquidity and depth of the financial markets. To control for the size of an economy I used GDP levels. Additionally, I used inflation rates to control for macroeconomic stability. Finally, unemployment rates are used to measure the state of the labour market. Results from the regression analyses were mostly insignificant. Only for the venture capital ratio the level of GDP had a significant (.000) but negative relationship. All the other variables failed to explain the substitution behavior.
7. Limitations and future research
This study was unique in the sense that it investigated private equity activity since the financial crisis as a substitute for bank lending to non-financial corporations. As this was the first study in this field, several new questions and areas for improvement became evident during the course of this research. I will provide my lessons learned from this study so they can serve as building blocks for future research on this topic.
A first limitation for this study was a lack of data. For most of the variables data was available for the years 2009 until 2013, leaving out the crisis years 2007 and 2008. However, data on bond market was only available up to 2011. But every year more information becomes available on post crisis behavior. A follow up study could include additional post crisis years when this information becomes available.
The development of the private equity market varies greatly among European countries. It is difficult to build a model with countries where the private equity activity fluctuates heavily. Therefore, focusing on countries with mature private equity markets first can be a good starting point.
Finally, for this study I have focussed only on economic factors that influenced both the private equity and bank lending activity. Future research could also study institutional factors for example regulation.
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Appendix
Additional theory on bank lending
Cornett et al. (2011) also studied the effects of the financial crisis on bank lending, but focussed on the role of liquidity risk management. They show that banks holding more illiquid assets (funded by sources other than core deposits and equity) reduced lending more than other banks in order to increase their liquid assets. Moreover, banks with greater unused credit lines increased their lending more than other banks, because borrowers drew more credit from existing credit lines when other sources of funding were unavailable.
according to Cole’s analysis banks receiving the TARP funds failed to increase their lending to small firms, they even decreased their lending to small firms even more than other banks.
Figure 1: According to these results bank lending has decreased since the financial crisis. Also the corporate bond market has increased, which supports the research by Kaya et al. (2014).
Figure 3: All the data on private equity investments. Even as a log the data is vary diverse, making clustering impossible.
Figure 4: All data on Total funds. Again the data varies too much to create clusters.
Figure 5: All data on the private equity ratio. The ratio regression models contain country dummy variables because the data varies too much to create clusters.
Figure 6: Coefficients table for regression model 3. A large share of the model is explained by the country dummy variables.
Figure 7: Descriptive statistics for the dependent and independent variables used for the regression models.
