Journal of Law, Finance, and Accounting > Vol 8 > Issue 1

Deciphering Private Equity Incentive Contracting and Fund Leverage Choice

Timothy J. Riddiough, Wisconsin School of Business, University of Wisconsin–Madison, USA,
Suggested Citation
Timothy J. Riddiough (2024), "Deciphering Private Equity Incentive Contracting and Fund Leverage Choice", Journal of Law, Finance, and Accounting: Vol. 8: No. 1, pp 55-89.

Publication Date: 22 Feb 2024
© 2024 T. J. Riddiough
Corporate finance,  Derivatives: Financial engineering,  Financial markets: Financial intermediation,  Disclosure,  Management control,  Management structure, governance and performance,  New business financing :Venture capital and private equity capital,  Principal-Agent
JEL Codes: D86, G21, G23, G32, L14, R33
Mechanism designprivate equityreal estateincentive contractingfeesdebtcapital structure


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In this article:
Preliminaries: Some New Empirical Facts and Relations 
LP Performance Measurement, Parameter Selection, and Model Calibration 
LP Return Targeting, GP Skill Heterogeneity, and Catch-Up Provisions 


In this paper I collect fee, leverage, and target return data, using it to calibrate a structural model of private equity fund leverage choice. The empirically calibrated model generates outputs that closely match moments in the data. The modeling process includes developing a tradeoff theory of fund capital structure and a theory of investor return targeting. Catch-up fee provisions in incentive contracts enable more skillful fund managers to extract higher fees while also satisfying investors' levered return targets. Results indicate that fixed carry hurdle rate and share percentage contracting terms are used to help screen lower-skill fund managers from the PE market.