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Pay for Performance from Future Fund Flows: The Case of Private Equity

Review of Financial Studies, Forthcoming

Charles A. Dice Center Working Paper No. 2010-003

Fisher College of Business Working Paper No. 2010-3-003

52 Pages Posted: 20 Feb 2010 Last revised: 11 Dec 2011

Ji-Woong Chung

Korea University - Department of Finance

Berk A. Sensoy

Vanderbilt University - Finance

Lea Henny Stern

University of Washington - Michael G. Foster School of Business

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 19, 2011

Abstract

Lifetime incomes of private equity general partners (GPs) are affected by their current funds’ performance not only directly, through carried interest profit-sharing provisions, but also indirectly by the effect of the current fund’s performance on GPs’ abilities to raise capital for future funds. In the context of a rational learning model, which we show better matches the empirical relations between future fundraising and current performance than behavioral alternatives, we estimate that indirect pay for performance from future fundraising is of the same order of magnitude as direct pay for performance from carried interest. Consistent with the learning framework, indirect pay for performance is stronger when managerial abilities are more scalable and weaker when current performance is less informative about ability. Specifically, it is stronger for buyout funds than for venture capital funds, and declines in the sequence of a partnership’s funds. Total pay for performance in private equity is both considerably larger and much more heterogeneous than implied by the carried interest alone. Our framework can be adapted to estimate indirect pay for performance in other asset management settings.

Keywords: Private Equity, Venture Capital, Fundraising, Compensation, Incentives

JEL Classification: G23, G24

Suggested Citation

Chung, Ji-Woong and Sensoy, Berk A. and Stern, Lea Henny and Weisbach, Michael S., Pay for Performance from Future Fund Flows: The Case of Private Equity (November 19, 2011). Review of Financial Studies, Forthcoming; Charles A. Dice Center Working Paper No. 2010-003; Fisher College of Business Working Paper No. 2010-3-003. Available at SSRN: https://ssrn.com/abstract=1554626

Ji-Woong Chung

Korea University - Department of Finance ( email )

Seoul, 136-701
United States

Berk A. Sensoy

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

Lea Henny Stern

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Michael S. Weisbach (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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