UC Santa Cruz UC Santa Cruz Electronic Theses and Dissertations Title Design, Development and Implementation of Decision Support Systems for Private Equity Investment Permalink https://escholarship.org/uc/item/4197h0m5 Author Vroomen, Paul Publication Date 2017 License https://creativecommons.org/licenses/by-nc-nd/4.0/ 4.0 Peer reviewed|Thesis/dissertation eScholarship.org Powered by the California Digital Library University of California UNIVERSITY OF CALIFORNIA SANTA CRUZ DESIGN, DEVELOPMENT AND IMPLEMENTATION OF DECISION SUPPORT SYSTEMS FOR PRIVATE EQUITY INVESTMENT A dissertation submitted in partial satisfaction of the requirements for the degree of DOCTOR OF PHILOSOPHY in TECHNOLOGY AND INFORMATION MANAGEMENT By Paul H.F. Vroomen June 2017 The Dissertation of Paul H.F. Vroomen is approved: ____________________________________ Subhas Desa, chair ____________________________________ Nirvikar Singh ____________________________________ Patrick Mantey _________________________ Tyrus Miller Vice Provost and Dean of Graduate Studies Copyright © by Paul H.F. Vroomen 2017 ii Table of Contents LIST OF FIGURES .................................................................................................................................... V LIST OF TABLES ................................................................................................................................... XII ABSTRACT ........................................................................................................................................... XIV DEDICATION ....................................................................................................................................... XVI ACKNOWLEDGEMENTS .................................................................................................................. XVII 1. INTRODUCTION .............................................................................................................................. 1 1.1. BACKGROUND ........................................................................................................................................ 1 1.2. RESEARCH ISSUES ................................................................................................................................. 3 1.3. RESEARCH CONTRIBUTIONS ............................................................................................................... 6 1.4. ORGANIZATION OF THE THESIS ......................................................................................................... 9 2. PROBLEM STATEMENT ............................................................................................................. 10 2.1. THESIS PROBLEM STATEMENT ....................................................................................................... 10 2.2. OVERVIEW OF THE IDSS .................................................................................................................. 10 3. DEFINING A SUCCESSFUL PRIVATE EQUITY INVESTMENT ........................................... 15 3.1 INTRODUCTION ........................................................................................................................................ 15 3.2 ORGANIZATION OF THE CHAPTER ........................................................................................................ 16 3.3 PROBLEM FORMULATION ...................................................................................................................... 17 3.3.1 Approach .......................................................................................................................................... 17 3.4 LITERATURE SURVEY ............................................................................................................................. 20 3.4.1 Modern Portfolio Theory ........................................................................................................ 21 3.4.2 The Theory of Efficient Markets ......................................................................................... 23 3.4.3 EBO and VC Rates of Return .................................................................................................. 24 3.4.4 Angel Investment Rates of Return .................................................................................... 24 3.4.5 ECF Rates of Return ................................................................................................................... 25 3.5 THEORETICAL FRAMEWORK ................................................................................................................. 25 3.5.1 Internal Rate of Return ........................................................................................................... 26 3.5.2 Modern Portfolio Theory ........................................................................................................ 29 3.5.3 Efficient Market Theory .......................................................................................................... 31 3.5.4 The Central Limit Theorem ................................................................................................... 36 3.6 APPLICATION ........................................................................................................................................... 37 3.6.1 Data .................................................................................................................................................... 37 3.6.1.1 Survivorship Bias ................................................................................................................................................... 39 3.6.1.2. Private Equity Buy-Out ...................................................................................................................................... 41 3.6.1.3. Venture Capital ...................................................................................................................................................... 42 3.6.1.4. Angel Investors ...................................................................................................................................................... 43 3.6.1.5 Addressing Limitations of Modern Portfolio Theory ............................................................................. 45 3.6.2 Normative Model for Private Equity Investment ..................................................... 55 3.6.2.1 ECF Systematic Risk .............................................................................................................................................. 55 3.6.2.2 Normative model for private equity investments ................................................................................... 58 3.7 RESULTS .................................................................................................................................................... 62 3.7.1 Target IRR for Individual ECF Investments ................................................................. 62 3.7.2 The Feasible Parameter Space for a Technology Start-Up ................................. 67 3.7.2.1 DCF Enterprise Model Assumptions .............................................................................................................. 69 iii 3.7.2.2 Results ........................................................................................................................................................................ 72 3.8 CONCLUSIONS .......................................................................................................................................... 73 4. CLASSIFYING PROSPECTIVE INVESTMENTS ...................................................................... 75 4.1 INTRODUCTION ........................................................................................................................................ 75 4.2 ORGANIZATION OF THE CHAPTER ........................................................................................................ 77 4.3 PROBLEM FORMULATION ...................................................................................................................... 78 4.4 LITERATURE SURVEY ............................................................................................................................. 79 4.4.1 Attribute Selection ..................................................................................................................... 79 4.4.2 Model Selection and Validation .......................................................................................... 82 4.5 THEORETICAL FRAMEWORK ................................................................................................................. 84 4.5.1 Attribute Selection ..................................................................................................................... 84 4.5.2 Model Selection ............................................................................................................................ 86 4.5.2.1 The 0.632+Bootstrap Algorithm ..................................................................................................................... 86 4.5.2.2 The Paired t-test ..................................................................................................................................................... 97 4.5.2.3 The Permutation Test (Standalone t-test) .................................................................................................