The illiquidity puzzle: Theory and evidence from private equity

  • Lerner J
  • Schoar A
  • 162


    Mendeley users who have this article in their library.
  • 81


    Citations of this article.


This paper presents the theory that managers can use the liquidity of securities as a choice variable to screen for deep-pocket investors, those that have a low likelihood of facing a liquidity shock. We assume an information asymmetry about the quality of the manager between the existing investors and the market. The manager then faces a lemons problem when he has to raise funds for a subsequent fund from outside investors, because the outsiders cannot determine whether the manager is of poor quality or the existing investors were hit by a liquidity shock. Thus, liquid investors can reduce the manager's cost of capital in future fundraising. We test the assumptions and predictions of our model in the context of the private equity industry. Consistent with the theory, we find that transfer restrictions on investors are less common in later funds organized by the same private equity firm, where information problems are presumably less severe. Also, partnerships whose investment focus is in industries with longer investment cycles display more transfer constraints. Finally, we present evidence consistent with the assumptions of our model, including the high degree of continuity in the investors of successive funds and the ability of sophisticated investors to anticipate funds that will have poor subsequent performance. © 2003 Elsevier B.V. All rights reserved.

Author-supplied keywords

  • Corporate finance
  • Fundraising
  • Liquidity
  • Venture capital

Get free article suggestions today

Mendeley saves you time finding and organizing research

Sign up here
Already have an account ?Sign in

Find this document


  • Josh Lerner

  • Antoinette Schoar

Cite this document

Choose a citation style from the tabs below

Save time finding and organizing research with Mendeley

Sign up for free