Do Private Equity Funds Earn Their Fees?

November 28, 2012

It’s widely known that private equity (PE) managers charge fees to limited partner investors (LPs) in their funds. These fees have historically been “2 and 20”: a 2 percent management fee on committed capital and 20 percent of carried interest, i.e., the profit from the investment above an agreed upon base return.

Fee structures are negotiated between LPs and PE managers when the fund is created. At times, fees have come under scrutiny by critics who argue that high fees dampened managers’ incentives to deliver strong investment performance.

The results of a study by David Robinson and Berk Sensoy shed light on the question of whether PE managers earn their fees. Do higher fees translate into superior returns? The answer is yes. According to this study, PE managers with higher compensation earn back their pay by delivering higher performance to LP investors. In this way, the fees negotiated between LPs and PE managers at the start of the fund represent “efficient bargaining outcomes.”

To learn more about academic research on private equity, go to the PEGCC’s Research Page.

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