Not Quite a Piece of Cake: Theory and Evidence of Compensation in U.S. Venture Capital Partnerships

66 Pages Posted: 18 Mar 2012

See all articles by Niklas Hüther

Niklas Hüther

Indiana University - Kelley School of Business

David T. Robinson

Fuqua School of Business, Duke University; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Soenke Sievers

Paderborn University

Thomas Hartmann-Wendels

University of Cologne - Department of Banking

Date Written: March 15, 2012

Abstract

Using a novel dataset including limited partnership agreements (LPAs) and corresponding funds’ cash in- and out-flows in every portfolio company, we analyze incentive effects induced by different distribution rules of general partner (GP)-friendly (deal-by-deal) versus limited partner (LP)-friendly (fund-as-a-whole) compensation contracts on the return and risk characteristics of U.S. venture capital (VC) funds. So far there is little research on performance and related compensation schemes, still only focusing on two components, i.e., 1) carried interest and 2) management fee (e.g., Gompers and Lerner 1999a, Robinson and Sensoy 2011). Through our precise treatment of legal terms, we are able to examine this third key component of venture capital contracts, i.e., the distribution rules, as introduced by Litvak (2009) which sets out in which priority investment profits will be paid out. As VC funds last for ten or more years and are characterized by restricted liquidity, distribution rules can be seen as the driving force for inducing incentives. The empirical results are consistent with our theoretical model predictions that GP-friendly rules lead to higher gross fund returns and higher risk, despite this risk is borne by the GP attributable to clawback provisions. Furthermore, being provided with all internal data regarding each deal our findings are robust to an extensive battery of robustness checks including a comprehensive set of control variables and using various econometric techniques. For example, we control for carried interest and management fee arrangements and confirm studies by, e.g., Gompers and Lerner (1999a) or Robinson and Sensoy (2011), that both contract terms are not associated with fund performance. Finally, we discuss the implications of our findings for researchers and investors regarding compensation schemes.

Keywords: executive compensation, venture capital , partnership, deal-by-deal, fund-as-a-whole

JEL Classification: G24, M12

Suggested Citation

Hüther, Niklas and Robinson, David T. and Sievers, Soenke and Hartmann-Wendels, Thomas, Not Quite a Piece of Cake: Theory and Evidence of Compensation in U.S. Venture Capital Partnerships (March 15, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2024515 or http://dx.doi.org/10.2139/ssrn.2024515

Niklas Hüther (Contact Author)

Indiana University - Kelley School of Business ( email )

1275 E 10th St
Bloomington, IN 47405
United States

David T. Robinson

Fuqua School of Business, Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0120
United States
919-660-8023 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

Soenke Sievers

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

HOME PAGE: http://www.upb.de/accounting

Thomas Hartmann-Wendels

University of Cologne - Department of Banking ( email )

Albertus-Magnus-Platz
D-50923 Cologne
Germany

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