A Model of Private Equity Fund Compensation

27 Pages Posted: 4 Nov 2011

See all articles by Wonho Wilson Choi

Wonho Wilson Choi

KAIST

Andrew Metrick

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Ayako Yasuda

University of California, Davis - Graduate School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: November 2011

Abstract

This paper analyzes the economics of the private equity fund compensation. We build a novel model to estimate the expected revenue to fund managers as a function of their investor contracts. In particular, we evaluate the present value of the fair-value test (FVT) carried interest scheme, which is one of the most common profit-sharing arrangements observed in practice. We extend the simulation model developed in Metrick and Yasuda (2010a) and compare the relative values of the FVT carry scheme to other benchmark carry schemes. We find that the FVT carry scheme is substantially more valuable to the fund managers than other commonly observed (and more conservative) carry schemes, largely due to the early timing of carry compensation that frequently occurs under the FVT scheme. Interestingly, conditional on having an FVT carry scheme, fund managers' incremental gains from inflating the reported values of the funds' un- exited portfolio companies would be negligible.

Suggested Citation

Choi, Wonho Wilson and Metrick, Andrew and Yasuda, Ayako, A Model of Private Equity Fund Compensation (November 2011). NBER Working Paper No. w17568. Available at SSRN: https://ssrn.com/abstract=1954495

Wonho Wilson Choi (Contact Author)

KAIST ( email )

85 Hoegiro, Dongdamoon
Seoul, 130-722
Korea

Andrew Metrick

Yale School of Management ( email )

165 Whitney Avenue
New Haven, CT 06511
United States
(203)-432-3069 (Phone)

HOME PAGE: http://faculty.som.yale.edu/andrewmetrick/

National Bureau of Economic Research (NBER) ( email )

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Yale University - Yale Program on Financial Stability

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P.O. Box 208200
New Haven, CT 06520-8200
United States

Ayako Yasuda

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Davis, CA 95616
United States
530-752-0775 (Phone)
530-752-2924 (Fax)

HOME PAGE: http://www.ayakoyasuda.com

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