The Economics of Private Equity

The development of theory about private equity during the last decades follows the pattern of economic development. While buyouts have found their origin in restructuring we observe more recently a trend of facilitating growth, where the firm and financier follow a path of acquisitions. A traditional valuation analysis approaches the investment problem from the perspective of a single transaction. New trends ask for an expanded valuation framework, not only to evaluate individual acquisitions but to shape the strategic thinking process. This address describes a framework for applying real options and game theory to strategy planning and valuation. It treats an acquisition strategy as a package of corporate real options, actively managed by the firm in a context of competitive responses or changing market conditions. Combining the quantitative options models developed in finance with game theory principles from economics and the qualitative insights from strategic management theory provides a richer framework that helps us better understand the restructuring of fragmented markets.