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. This paper was accepted by Bruno Biais, finance. Funding: V. Maurin thanks the Swedish House of Finance for financial support. P. Strömberg thanks the NASDAQ Nordic Foundation, Söderberg Professorship in Economics, and Swedish House of Finance for financial support. D. Robinson thanks the Bertil Danielsson Professorship and Erling Persson Professorship for financial support. Supplemental Material: The online appendices are available at https://doi.org/10.1287/mnsc.2022.4612 .
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
