Modifying The Carried Interest To Do What It Is Said To Do

8 Pages Posted: 15 Feb 2019 Last revised: 21 Feb 2019

See all articles by Ludovic Phalippou

Ludovic Phalippou

University of Oxford - Said Business School; University of Oxford - Oxford-Man Institute of Quantitative Finance

Date Written: February 12, 2019

Abstract

The carried interest received by private equity fund managers (General Partners; GPs) generates some controversies. The three most debated claims are that carried interest i) aligns incentives, ii) should be treated as a capital gain for tax purposes, and iii) should not be reported as a fee charged to investors. The existence of two key principal-agent relationships within the private equity model might be at the root of these controversies. One relationship links the GP as principal and portfolio company management team as agent. In this first contract, the three claims hold true. The other relationship links fund investors (Limited Partners; LPs) as principal with the GP as agent. I show that modifying that second contract by introducing a first-loss feature and reducing significantly the catch-up rate makes the two contracts equivalent. Hence, the benefits of the limited partnership structure can co-exist in a setting where the three claims about carried interest hold true.

Keywords: private equity, incentives alignment, carried interest

JEL Classification: G24

Suggested Citation

Phalippou, Ludovic, Modifying The Carried Interest To Do What It Is Said To Do (February 12, 2019). Available at SSRN: https://ssrn.com/abstract=3333053 or http://dx.doi.org/10.2139/ssrn.3333053

Ludovic Phalippou (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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