59 Infact,HullandWhite(2004)bringthistendencytoward
early exercise into the valuation of employee options by
assumingthatexercisewilloccurifthepriceappreciatesbya
prespecified percentage.
60 Thesecondcontextiswhentheunderlyingassetisitself
illiquidandthereareoptionsontheasset.Inthiscase,any
illiquidity discountthat appliestotheunderlyingasset will
also reduce the value of any options on that asset.
Private Equity
Private equity and venture capital investors often provide
capitaltoprivate businessesin exchangeforashare ofthe
ownershipinthesebusinesses.Implicitinthesetransactions
mustbetherecognitionthattheseinvestmentsarenotliquid.
Ifprivateequityinvestorsvalueliquidity,theywilldiscount
the value of the private business for this illiquidity and
demandalargershareoftheownershipofilliquidbusinesses
forthe sameinvestment.Lookingatthereturns earned by
privateequityinvestorsrelativetothereturnsearnedbythose
investing in publicly traded companies should provide a
measure of how much value they attach to illiquidity.
LjungquistandRichardson(2003)estimatethatprivateequity
investorsearnexcessreturnsof 5 to 8 percent,relativetothe
publicequitymarket,andthatthisgeneratesabout 24 percent
inrisk-adjustedadditionalvaluetoaprivateequityinvestor
over 10 years.
61 Theyarguethatthisrepresentscompensationforholding
an illiquidinvestment for 10 years. Das,Jagannathan, and
Sarin(2002)takeamoredirectapproachtoestimatingprivate
company discounts by looking at how venture capitalists