Measuring return expectations and capital costs in the European private capital markets: An alternative approach

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Abstract

Data collection on return expectations (Ret_Exp) and capital costs is still connected with high barriers and low transparency, especially in European private markets. This study suggests a questionnaire format to gather data from market participants derived from an approach seen in the USA by Slee and Paglia (2010, 2011). Moreover, it suggests that return expectations and cost of capital (CoC) should not be regarded as synonyms. A delta of approximately 1.2 percent can be observed when comparing mean values of both variables over various asset classes as real estate funds, venture capital, mezzanine investments, and direct investment from 213 data points collected in 2019/2020 primarily before the COVID-19 crisis as well as the Russia-Ukraine-conflict. This supports the general theory that return expectations incorporate the cost of capital structure, including a certain premium. In the second step, regressions are applied to identify influential factors on capital costs and return expectations in European private markets. The regressions suggest that the investment duration reduces these values. As a result, short-termism will lead to higher return expectations and capital costs, according to the model. Considering further variables indicates that specialization effects combined with a long investment horizon reduce both metrics for investors.

Keywords: Investment Criteria, Cost of Capital, Return Expectations, Private Equity, Private Markets

Authors’ individual contribution: Conceptualization — E.B.; Methodology — E.B.; Investigation — E.B. and T.A.H.; Resources — E.B.; Writing — E.B. and T.A.H.; Supervision — E.B. and T.A.H.

Declaration of conflicting interests: The Authors declare that there is no conflict of interest.

JEL Classification: G11, G14, G24, G32

Received: 29.04.2024
Accepted: 15.11.2024
Published online: 20.11.2024

How to cite this paper: Bossauer, E., & Herberger, T. A. (2024). Measuring return expectations and capital costs in the European private capital markets: An alternative approach. Risk Governance and Control: Financial Markets & Institutions, 14(4), 110–122. https://doi.org/10.22495/rgcv14i4p11