Friday, September 07, 2007

Why Private Equity?

Last month, Hamid Moghadam, CEO of AMB, spoke to my Wharton West class. He was a remarkable speaker.

AMB is an industrial REIT that has a private subsidiary whose existence is a puzzle to me. The REIT and the subsidiary share profits until the subsidiary reaches a return target, after which the public company gets the lion's share of the profit. In other words, the public and private companies split the risk, but the public company has more upside potential. This makes no sense in a Modigliani-Miller world (or any reasonable world, for that matter).

The benefit of the private company in this context is that it is not priced every day. Managers of institutional portfolios like this, because they don't have to report losses until they are realized. With stocks, managers can be measured on a minute-to-minute basis. Chris Mayer at Columbia, who knows more about this stuff than I, confirms that this can be a motivator for how fund managers choose their investments.


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