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An Option-Pricing Framework for the Valuation of Fund Management Compensation

In: Derivative Securities Pricing and Modelling

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  • Axel Buchner
  • Abdulkadir Mohamed
  • Niklas Wagner

Abstract

Compensation of funds managers increasingly involves elements of profit sharing that entitle managers to option-like payoffs. An important example is the compensation of private equity fund managers. Compensation of private equity fund managers typically consists of a fixed management fee and a performance-related carried interest. The fixed management fee resembles common compensation terms of mutual funds and hedge funds, while the performance-related carried interest is uncommon among most mutual funds. Moreover, the performance-related carried interest typically differs from variable hedge fund fees. In this chapter, we derive the value of the variable components of private equity fund managers’ compensation based on a risk-neutral option-pricing approach.

Suggested Citation

  • Axel Buchner & Abdulkadir Mohamed & Niklas Wagner, 2012. "An Option-Pricing Framework for the Valuation of Fund Management Compensation," Contemporary Studies in Economic and Financial Analysis, in: Derivative Securities Pricing and Modelling, pages 331-350, Emerald Group Publishing Limited.
    • Handle: RePEc:eme:csefzz:s1569-3759(2012)0000094016
    DOI: 10.1108/S1569-3759(2012)0000094016
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