Chapter 6 PE Questions

Chapter 6 PE Questions - Chapter 6 Compensation Contracts 1...

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Chapter 6 – Compensation Contracts 1. What are the typical compensation terms for private equity limited partnership fund managers? How would you expect compensation terms to vary across different countries? Private equity fund managers are compensated with a two part fee: a fixed managed fee (% of fund size) and a performance fee (carried interest). PE funds in the U.S. have fixed management fee of 1-3% of the committed capital and performance fees of 20%. Fixed management fees are there for meeting overheads from the investment and divestment process and the carried interest is to incentivize the fund manager on the institutional investors’ behalf. In regards to specific compensation terms, I expect that fund managers operating in countries with weaker legal conditions to accept higher fixed fees and lower performance fee. This is because information asymmetries are pronounced in such countries and therefore, investors are less likely to employ incentive contracts for fund managers and entrepreneurs. In addition, countries with weaker legal constitution have uncertain exit market where it is more difficult to obtain a capital gain and generate fund returns. Here, the fund manager would like to secure a certain income stream and opt for higher fixed fees in exchange for lower performance fees.
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