Private Equity Economics: Compensation and Growth Dynamics

Abstract

This paper investigates the compensation and growth dynamics of private equity firms. Using proprietary data, I estimate that about half of their revenue is performance-related and find that current fund performance also has indirect effects on firms’ future revenue. The dynamics of these indirect effects are different for buyout and venture capital (VC). For buyout firms, current fund performance is associated with larger increases in follow-on fund size, but not with fund economics. For VC firms, performance is more likely to impact future fund terms, which exhibit asymmetric effects. Nonetheless, most funds adopt “market-standard” compensation terms that often remain unchanged in follow-on funds. The results suggest that managers mainly grow revenue not by negotiating better compensation terms but by raising larger funds. As they raise follow-on funds, the proportion of expected managerial compensation from indirect compensation declines with managerial experience and is higher for buyout funds than VC funds.

Keywords: private equity, buyout, venture capital, compensation, performance

JEL Classification: G1, G2, G3, G17, G23, G24, G34, J33, G32, G35