Incentives in Private Equity: The Impact of Fee Structures on Investment Behavior

Abstract

Using three comprehensive datasets, I show that general partners (GPs) tend to overinvest in later investment phases to maximize fee revenues, even in unprofitable deals. These deals exhibit lower profit margin growth and net returns, especially in funds with superior performance and experienced GPs. From the perspective of limited partners (LPs), the results are driven by funds with higher contributions coming from public pension funds, which do not appear to penalize overinvestments. Overall, the results show that when LPs lack strong motivation to oversee GPs, skilled and experienced GPs can effectively self-compensate through overinvestment without increasing management fees.

Keywords: Private Equity, Agency Problems, Compensation Structure, Investment Cycle

JEL Classification: G23, G24, G29