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A Model of Private Equity Fund Compensation

In: The Global Macro Economy and Finance

Author

Listed:
  • Wonho Wilson Choi

    (Korea Advanced Institute of Science and Technology)

  • Andrew Metrick

    (Yale School of Management)

  • Ayako Yasuda

    (University of California)

Abstract

Private equity funds are typically organized as limited partnerships, with private equity firms serving as general partners (GPs) of the funds and investors providing capital as limited partners (LPs). These partnerships usually last for ten years, and partnership agreements (investor contracts) signed at the funds’ inceptions clearly define the expected GP compensation. Since the payments to GPs can account for a significant portion of the total cash flows of the fund, the fund fee structure is a critical determinant of the expected net fund returns that the LPs receive. Metrick and Yasuda (2010a) estimate the expected present value of the compensation to GPs as a function of the fee structure specified in investor contracts, but do not consider the fair-value test (FVT) scheme, which is a commonly used carried interest scheme in practice.1 In this chapter, we evaluate the present value of the FVT carried interest scheme by extending the simulation model developed in Metrick and Yasuda (2010a), and compare the relative values of the FVT carry scheme to other benchmark carry schemes.

Suggested Citation

  • Wonho Wilson Choi & Andrew Metrick & Ayako Yasuda, 2012. "A Model of Private Equity Fund Compensation," International Economic Association Series, in: Franklin Allen & Masahiko Aoki & Jean-Paul Fitoussi & Nobuhiro Kiyotaki & Roger Gordon & Joseph E. S (ed.), The Global Macro Economy and Finance, chapter 14, pages 271-286, Palgrave Macmillan.
    • Handle: RePEc:pal:intecp:978-1-137-03425-0_15
    DOI: 10.1057/9781137034250_15
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    References listed on IDEAS

    as
    1. Andrew Metrick & Ayako Yasuda, 2011. "Venture Capital and Other Private Equity: a Survey," European Financial Management, European Financial Management Association, vol. 17(4), pages 619-654, September.
    2. Briys, Eric & de Varenne, François, 1997. "Valuing Risky Fixed Rate Debt: An Extension," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(2), pages 239-248, June.
    3. Inmoo Lee & Scott Lochhead & Jay Ritter & Quanshui Zhao, 1996. "The Costs Of Raising Capital," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 19(1), pages 59-74, March.
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    Cited by:

    1. Andrew Metrick & Ayako Yasuda, 2011. "Venture Capital and Other Private Equity: a Survey," European Financial Management, European Financial Management Association, vol. 17(4), pages 619-654, September.
    2. Dorra Najar, 2014. "Fund Managers Fees: Estimation and Sensitivity Analysis Using Monte Carlo Simulation," Working Papers 2014-195, Department of Research, Ipag Business School.
    3. Dorra Najar, 2017. "Private equity managers’ fees: estimation and sensitivity analysis using Monte Carlo simulation," Review of Quantitative Finance and Accounting, Springer, vol. 48(1), pages 239-263, January.
    4. Niklas Hüther & David T. Robinson & Sönke Sievers & Thomas Hartmann-Wendels, 2020. "Paying for Performance in Private Equity: Evidence from Venture Capital Partnerships," Management Science, INFORMS, vol. 66(4), pages 1756-1782, April.

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    More about this item

    Keywords

    Venture Capital; Private Equity; Venture Capital Fund; Portfolio Company; Private Equity Fund;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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