Working Paper: NBER ID: w16369
Authors: Jiwoong Chung; Berk A. Sensoy; Lea H. Stern; Michael S. Weisbach
Abstract: Lifetime incomes of private equity general partners are affected by their current funds' performance through both carried interest profit sharing provisions, and also by the effect of the current fund's performance on general partners' abilities to raise capital for future funds. We present a learning-based framework for estimating the market-based pay for performance arising from future fundraising. For the typical first-time private equity fund, we estimate that implicit pay for performance from expected future fundraising is approximately the same order of magnitude as the explicit pay for performance general partners receive from carried interest in their current fund, implying that the performance-sensitive component of general partner revenue is about twice as large as commonly discussed. Consistent with the learning framework, we find that implicit pay for performance is stronger when managerial abilities are more scalable and weaker when current performance contains less new information about ability. Specifically, implicit pay for performance is stronger for buyout funds compared to venture capital funds, and declines in the sequence of a partnership's funds. Our framework can be adapted to estimate implicit pay for performance in other asset management settings in which future fund flows and compensation depend on current performance.
Keywords: private equity; pay for performance; fundraising
JEL Codes: G24; G30; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| likelihood of raising follow-on funds (p_i) (G24) | size of follow-on fund (f_i) (G23) |
| current fund performance (IRR) (G23) | likelihood of raising follow-on funds (p_i) (G24) |
| current fund performance (IRR) (G23) | size of follow-on fund (f_i) (G23) |