Weisbach Professor and Ralph W. Kurtz Chair in Finance at The Ohio State
University, and his colleagues, Ji-Woong Chung, Berk A. Sensoy and Léa H.
Stern, are looking at the effect of the pay for performance at private equity
funds. One hand, there is the current income from management fees and a
percentage of the profit earned by the fund. On the other hand, there is the
potential future income from future funds.
A fund sponsor's lifetime income can be as dependent on
the ability to raise capital in the future as it is for the income on capital
currently under management. A fund sponsor's "total pay for performance equals
the sum of pay for performance features of the explicit compensation contract
and the implicit, market-based pay for performance caused by the relation
between today's performance and future fundraising."
Weisbach takes a closer look at the magnitude of pay for
performance for private equity fund managers.
The results are not particularly surprising:
For all types of funds, both the probability of raising a
follow-on fund and the size of the follow-on conditional on raising one are
significantly positively related to the performance of the current fund. The
magnitude of these relations varies with the scalability of the investments. Buyout
funds, which are the most scalable, have the strongest relation, while venture
capital funds, which are the least scalable, have the weakest relation.
We also find that these relations are stronger for funds
that are earlier in a partnership's sequence of funds, that is, younger
partnerships have stronger relations between future fundraising and current
fund returns than older partnerships. This suggests that fund flows in the
private equity industry reflect learning about ability over time, and that the
strength of the market-based, implicit pay for performance facing a private
equity partnership depends on the extent of its prior track record.
The paper does have some interesting data on private
equity funds and their operations:
In the end, they conclude that the implicit component of
pay for future performance from future funds is on the same order of magnitude
as the explicit component of compensation in the carried interest of the
current fund. That sounds like a fund manager's interests are well aligned with
the long term interest of the investors in its funds. That's something that
public companies continue to struggle with.
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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