Working Paper: CEPR ID: DP10448
Authors: Massimo Massa; Hong Zhang; Xiaolan Zhou
Abstract: We investigate an informal yet important mechanism in the private equity industry that helps to reduce uncertainty: relationship building. Based on a large sample of private equity funds over the 1980-2010 period, we find that the general partners strategically allocate good funds to loyal investors, who in turn commit to invest also in new funds that are not ex-ante promising. In addition, this effect is stronger for venture capital (VC) funds and more popular among certain types of investors. The bargaining power of the relationship concentrates in the hand of GPs.
Keywords: performance; private equity; relationship
JEL Codes: G20; L10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| GPs strategically allocate better-performing funds to loyal LPs (G23) | LPs commit to investing in new funds (G23) |
| LPs commit to investing in new funds (G23) | reduce capital uncertainty for GPs (G39) |
| LPs commit to investing in new funds (G23) | reduce investment uncertainty for LPs (G11) |
| GP's track record and LP-GP relationship can significantly predict fund performance (C52) | increase in annual fund performance (G23) |
| LP-GP relationship reduces sensitivity of capital flows to fund performance (F21) | implicit insurance role played by related LPs (G23) |
| GPs leverage their relationships to strategically allocate funds (G23) | mitigate uncertainty in capital raising (G24) |