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A Theory of Liquidity in Private Equity

Author

Listed:
  • Vincent Maurin

    (Stockholm School of Economics, Swedish House of Finance, 11160 Stockholm, Sweden)

  • David T. Robinson

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708; National Bureau of Economic Research, Cambridge, Massachusetts 02138)

  • Per Strömberg

    (Stockholm School of Economics, Swedish House of Finance, 11160 Stockholm, Sweden; Centre for Economic Policy Research, London EC1V0DX, United Kingdom; European Corporate Governance Institute, c/o the Royal Academies of Belgium, 1000 Brussels, Belgium)

Abstract

We develop a model of private equity capturing two fundamental features of this market: the fund structure and illiquidity. A fund structure with sequential capital calls arises as an optimal solution to fund managers’ (GPs) moral hazard problem but exposes investors (LPs) to illiquidity risk. Funds with more illiquidity-tolerant LPs realize higher returns, leading to different expected returns across both funds and LPs in equilibrium. GPs may inefficiently accelerate drawdowns to avoid default by LPs on capital commitments. With a secondary market for LP claims, differences in fund returns are attenuated but differences in LP returns remain. The model can rationalize several empirical findings on primary and secondary private equity markets.

Suggested Citation

  • Vincent Maurin & David T. Robinson & Per Strömberg, 2023. "A Theory of Liquidity in Private Equity," Management Science, INFORMS, vol. 69(10), pages 5740-5771, October.
    • Handle: RePEc:inm:ormnsc:v:69:y:2023:i:10:p:5740-5771
    DOI: 10.1287/mnsc.2022.4612
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