“Do Private Equity Firms Misbehave?”

Ranko Jelic (University of Sussex)

LTI@UniTO Colloqium

Abstract: Consistent with early predictions, the private equity (PE) industry has grown tremendously and become a global phenomenon. The 2007-08 financial crisis, however, highlighted the cyclical nature of PE investments and initiated a debate about PE funds’ role in the economy and their managerial compensation. For example, PE industry is characterised by large information asymmetry and illiquid capital allocation decisions by limited partners (LPs). Since private investments are not traded on an exchange, PE firms report less frequently and their valuation is based on a model rather than on market transactions. The valuation is therefore marked-to-market and often delayed. Importantly, according to the “2 and 20” model, management fees are performance insensitive while carried interest is not. This can potentially create incentives for general partners (GP) to engage in opportunistic behaviour and exaggerate fund performance. Our findings highlight potential agency conflicts between GPs and investors and contribute to the debate regarding regulatory measures aiming to increase transparency in the PE industry.

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