Private Equity Intra-Fund Persistence: Fund Performance in Consideration of Direct and Indirect Compensation

Abstract

Private equity fund managers (PEM, or the general partner/GP) exhibit certain performance persistence, or lack thereof, over time. Most scholarly research to date examines inter-fund performance persistence, or the performance at a fund level across multiple specific funds over time. This dissertation examines intra-fund performance, i.e., performance within a specific fund, and posits that investments made later in a specific private equity fund’s lifespan will perform worse than earlier investments, reflecting agency cost in terms of residual loss to principals as a result of the direct and indirect compensation structures. Using ROIC (Return on Invested Capital) and the sequence in which investments are made in a fund as empirical evidence of these negative effects of the compensation and contractual arrangements common throughout the industry. This performance analysis will be done within each specific fund in consideration of the effects of both direct compensation from the current fund and indirect compensation expectations of the PEM from future funds. This dissertation relies on agency theory to explain the incentives and costs that lead to a negative relationship between the sequence of an investment in a fund’s life and the ROIC of the specific investment. Concepts of risk sharing and information asymmetry, specifically from an agency theory perspective, and the misalignment of interested between investors and PEM support this hypothesis. The most notably areas impacted by this research relate to governance (both investors and public policy), compensation, and incentive structure of private equity funds.