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

46 Pages Posted: 20 Sep 2010

See all articles by Ji-Woong Chung

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); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: September 2010

Abstract

Lifetime incomes of private equity general partners are affected by their current funds' performance through both carried interest profit sharing provisions, and also by the effect of the current fund's performance on general partners' 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 partnership's 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.

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 (September 2010). NBER Working Paper No. w16369. Available at SSRN: https://ssrn.com/abstract=1678912

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

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

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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