turnoverandanemphasisonrisky,smallmarketcapstocksto
underperform the market.
80 Extending this analysis to venture capital and private
equityinvestments,illiquidityshouldbeanevenbiggerfactor
in investment choices. Private equity investors, when
negotiatingforashareofthebusinessthattheyshouldreceive
inexchangeforsupplyingfunds,havetoconsiderhowmuch
to discount the value for illiquidity.
Thereareconsequencesforperformanceevaluationaswell.
Withpubliclytradedstocks,wegenerallyusemarketpricesto
measure returns, and these prices should reflect the
consequences of illiquidity directly. In other words, a
portfoliomanagerwhoinvestsprimarilyinlessliquidstocks
willnot gainan advantage over one who invests in more
liquid stocks, if total returns are adjusted for transactions
costs.Withprivate equityandventurecapitalfunds,where
the assets arenot traded and the valuations are generated
internally (by the fund managers), the stated value of a
portfolio may be misleadingif illiquidity is not explicitly
factoredintothevalue.Ingeneral,this willleadtoreturns
beingoverstatedatfundswithmoreilliquidinvestments,and
themagnitudeofthemisstatementwillbegreaterinperiods
of overall market illiquidity (when liquidity commands a
greater premium).
81
Corporate Finance
Therearetwolevelsatwhichilliquiditycanaffectcorporate
financial decisions.Thefirst relates to the liquidityof the
securities (stocks and/or bonds) issued by a firm to raise