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Institute for Financial Research SIFR Research Report Series, Institute for Financial Research

No 77:
Pay for Performance from Future Fund Flows: The Case of Private Equity

Ji-Woong Chung, Berk A. Sensoy, Lea H. Stern and Michael S. Weisbach ()

Abstract: Lifetime incomes of private equity general partners are affected by their current fundsí performance through both carried interest profit sharing provisions, and also by the effect of the current fundís performance on general partnersí abilities to raise capital for future funds. We present a learning-based framework for estimating the market-based pay for performance arising from future fundraising. For the typical first-time private equity fund, we estimate that implicit pay for performance from expected future fundraising is approximately the same order of magnitude as the explicit pay for performance general partners receive from carried interest in their current fund, implying that the performance-sensitive component of general partner revenue is about twice as large as commonly discussed. Consistent with the learning framework, we find that implicit pay for performance is stronger when managerial abilities are more scalable and weaker when current performance contains less new information about ability. Specifically, implicit pay for performance is stronger for buyout funds compared to venture capital funds, and declines in the sequence of a partnershipís funds. Our framework can be adapted to estimate implicit pay for performance in other asset management settings in which future fund flows and compensation depend on current performance.

Keywords: Private equity; Venture capital; Fundraising; Compensation; Incentives; (follow links to similar papers)

JEL-Codes: G23; G24; (follow links to similar papers)

44 pages, September 22, 2010

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