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Beware of Venturing into Private Equity

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  • Ludovic Phalippou

Abstract

As a step towards understanding whether a private equity governance structure reduces overall agency conflicts relative to a public equity governance structure (as is often argued), this paper describes the contracts between private equity funds and investors, and the returns earned by investors. The paper sets the stage with a puzzle: the average performance of private equity funds is above that of the Standard and Poor's 500 - the main public stock market index - before fees are charged, but below that benchmark after fees are charged. Why are the payments to private equity buyout funds so large? Why does the marginal investor invest in buyout funds? I explore one potential answer (and probably the most controversial): that some investors are fooled. I show that the fee contracts for these funds are opaque. Considering this and the way that compensation contracts bury, in details, costly provisions that are difficult to justify on the basis of proper incentive alignment, it would be premature to assert that the agency conflicts are lower in private equity than in public equity.

Suggested Citation

  • Ludovic Phalippou, 2009. "Beware of Venturing into Private Equity," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 147-166, Winter.
    • Handle: RePEc:aea:jecper:v:23:y:2009:i:1:p:147-66
    Note: DOI: 10.1257/jep.23.1.147
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.23.1.147
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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