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Beware of Venturing into Private Equity

Author

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  • Ludovic Phalippou

Abstract

As a step towards understanding whether a private equity governance structure reduces overall agency conflicts relative to a public equity governance structure (as is often argued), this paper describes the contracts between private equity funds and investors, and the returns earned by investors. The paper sets the stage with a puzzle: the average performance of private equity funds is above that of the Standard and Poor's 500 - the main public stock market index - before fees are charged, but below that benchmark after fees are charged. Why are the payments to private equity buyout funds so large? Why does the marginal investor invest in buyout funds? I explore one potential answer (and probably the most controversial): that some investors are fooled. I show that the fee contracts for these funds are opaque. Considering this and the way that compensation contracts bury, in details, costly provisions that are difficult to justify on the basis of proper incentive alignment, it would be premature to assert that the agency conflicts are lower in private equity than in public equity.

Suggested Citation

  • Ludovic Phalippou, 2009. "Beware of Venturing into Private Equity," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 147-166, Winter.
  • Handle: RePEc:aea:jecper:v:23:y:2009:i:1:p:147-66
    Note: DOI: 10.1257/jep.23.1.147
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.23.1.147
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Andonov, Aleksandar & Eichholtz, Piet & Kok, Nils, 2015. "Intermediated investment management in private markets: Evidence from pension fund investments in real estate," Journal of Financial Markets, Elsevier, vol. 22(C), pages 73-103.
    2. A. Dyck & L. Pomorski, 2016. "Investor Scale and Performance in Private Equity Investments," Review of Finance, European Finance Association, vol. 20(3), pages 1081-1106.
    3. 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.
    4. Officer, Micah S. & Ozbas, Oguzhan & Sensoy, Berk A., 2010. "Club deals in leveraged buyouts," Journal of Financial Economics, Elsevier, vol. 98(2), pages 214-240, November.
    5. Sebastian Di Tella, 2017. "Optimal Regulation of Financial Intermediaries," NBER Working Papers 23586, National Bureau of Economic Research, Inc.
    6. A. Edward Safarian, 2011. "International Mergers and Acquisitions," Chapters,in: International Handbook on the Economics of Integration, Volume III, chapter 6 Edward Elgar Publishing.
    7. Ron Bird & Harry Liem & Susan Thorp, 2011. "Private Equity: Strategies for Improving Performance," Working Paper Series 12, The Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology, Sydney.
    8. David T. Robinson & Berk A. Sensoy, 2012. "Do Private Equity Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance," NBER Working Papers 17942, National Bureau of Economic Research, Inc.
    9. Gregory W. Brown & Oleg R. Gredil & Steven N. Kaplan, 2016. "Do Private Equity Funds Manipulate Reported Returns?," NBER Working Papers 22493, National Bureau of Economic Research, Inc.
    10. Da Rin, M. & Phalippou, L., 2014. "There is Something Special About Large Investors : Evidence From a Survey of Private Equity Limited Partners," Discussion Paper 2014-016, Tilburg University, Center for Economic Research.
    11. Marko Rikato & Ales Berk, 2015. "Costliness of Placement Agents," Journal of Financial Services Research, Springer;Western Finance Association, vol. 48(3), pages 263-287, December.
    12. repec:eee:jfinin:v:31:y:2017:i:c:p:64-76 is not listed on IDEAS
    13. repec:spr:jbecon:v:88:y:2018:i:3:d:10.1007_s11573-017-0886-0 is not listed on IDEAS
    14. Ron Bird & Harry Liem & Susan Thorp, 2011. "Infrastructure: Real Assets and Real Returns," Working Paper Series 11, The Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology, Sydney.
    15. Bienz, Carsten & Thorburn, Karin & Walz, Uwe, 2016. "Coinvestment and risk taking in private equity funds," SAFE Working Paper Series 126, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    16. Wang, Yingdi, 2012. "Secondary buyouts: Why buy and at what price?," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1306-1325.
    17. Linus Siming, 2014. "Your Former Employees Matter: Private Equity Firms and Their Financial Advisors," Review of Finance, European Finance Association, vol. 18(1), pages 109-146.

    More about this item

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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