SSE/EFI Working Paper Series in Business Administration,
Stockholm School of Economics

Abstract: In this paper I build a simplified model of the remuneration structure of a private equity fund using option theory. This model is then used to analyze the relative importance of the fixed and variable fee parts. The model is complemented with a structural model to evaluate the financial choices of private equity fund managers. It turns out that the control over the financial structure is valuable to the fund manager, hence creating a conflict of interests.

From the fund managers point of view the increased expected fee resulting from the independent control over the financial structure of the fund is at some point off-set by the increasing risk in the fund. This creates a static trade-off point for a one fund manager. For a fund manager with future fund projects, there is also a dynamic trade-off between current expected fee and the ability to raise future funds.

Keywords: Private Equity; Fund manager; Fee structure

20 pages, First version: June 21, 2010. Revised: January 18, 2013.

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