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Private Equity in the 21st Century: Cash Flows, Performance, and Contract Terms from 1984-2010

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  • Robinson, David T.

    (Duke University)

  • Sensoy, Berk A.

    (Ohio State University)

Abstract

Using detailed quarterly cash flow data for a large sample of private equity funds from 1984-2010, we examine cross-sectional and time-series cash flow performance of private equity funds across a range of asset classes, including venture capital, buyout, real estate, distressed debt, and funds-of-funds. Our data also include key features of the management contracts, specifically carried interest, management fees, and general partner capital commitments, allowing us to investigate the determinants of contractual terms and to link contractual terms to performance. The data reveal important facts about the private equity market in the 21st century. On average, our sample pri-vate equity funds have outperformed the S&P 500 on a net-of-fee basis by about 15%, or about 1.5% per year. Performance varies considerably across fund types and over time. Larger funds require larger percentage capital commitments from the general partners (GPs), consistent with concerns about GP incentives in large funds. Larger funds also charge lower management fees, and obtain higher carried interest, consistent with learning about GP ability. Management fees, but not carried interest, are higher during fundraising boom periods, even controlling for fund size, suggesting that the fixed/variable mix of GP compensation shifts toward fixed components during fundraising booms, consistent with increased GP bargaining power in booms. In marked contrast to the mutual fund literature, there is no relation between management fee and carry terms and net-of-fee performance, suggesting that GPs with higher fees earn them in the form of higher gross-of-fee performance. There is some evidence that funds with lower GP capital commitments outperform. Conclusions about private equity performance over time differ markedly depending on whether performance is measured in absolute terms (IRR) or adjusted for the performance of the S&P 500 (PME). In particular, funds raised during hot markets underperform in terms of IRR, but not in terms of PME. Capital calls and distributions are both more likely and larger when public equity valuations rise and when liquidity conditions tighten. During the financial crisis and ensuing recession of 2007-2009, the component of calls unexplained by macroeconomic factors spiked, distributions plummeted, and the sensitivity of calls and distributions to underlying macroeconomic conditions changed considerably.

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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2010-21.

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Date of creation: Dec 2010
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Handle: RePEc:ecl:ohidic:2010-21

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  1. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  2. Steven Kaplan & Antoinette Schoar, 2003. "Private Equity Performance: Returns, Persistence and Capital," NBER Working Papers 9807, National Bureau of Economic Research, Inc.
  3. Kaplan, Steven N. & Strömberg, Per, 2009. "Leveraged Buyouts and Private Equity," SIFR Research Report Series 65, Institute for Financial Research.
  4. Alexander Ljungqvist & Matthew Richardson & Daniel Wolfenzon, 2008. "The Investment Behavior of Buyout Funds: Theory and Evidence," NBER Working Papers 14180, National Bureau of Economic Research, Inc.
  5. Axelson, Ulf & Strömberg, Per Johan & Weisbach, Michael, 2007. "Why are Buyouts Leveraged? The Financial Structure of Private Equity Firms," CEPR Discussion Papers 6133, C.E.P.R. Discussion Papers.
  6. Alexander Ljungqvist & Matthew Richardson, 2003. "The cash flow, return and risk characteristics of private equity," NBER Working Papers 9454, National Bureau of Economic Research, Inc.
  7. Josh Lerner & Antoinette Schoar & Wan Wong, 2005. "Smart Institutions, Foolish Choices? The Limited Partner Performance Puzzle," NBER Working Papers 11136, National Bureau of Economic Research, Inc.
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Cited by:
  1. David T. Robinson & Berk A. Sensoy, 2013. "Do Private Equity Fund Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance," Review of Financial Studies, Society for Financial Studies, vol. 26(11), pages 2760-2797.

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