Fund Managers Fees: Estimation and Sensitivity Analysis Using Monte Carlo Simulation
Fund managers compensation is a particular problem area in terms of its tax treatment in the United States and some European countries. This problem originates in the difficulty of defining these particular forms of incentive and therefore their estimated fair value. Based on the literature, carried interest, which is one of the most common profit-sharing arrangements observed in practice, may be considered as an option characterized by several constraints. The use of classical option-pricing models is inappropriate to take into account all these constraints. In this paper, we build a model to estimate the expected revenue to managers as a function of their investor contracts and we test how this estimated revenue varies across the characteristics of funds. We used the Monte Carlo simulation model and we introduced the non-marketability discount of the carried interest in order to calculate its fair value. A sensitivity analysis is performed in order to show the change in the fair value of carried interest after the change of each criterion. We find sharp differences between venture capital (VC) and buyout (BO) funds and between “deal by deal funds” and “whole funds”.
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