Is Greed Ruining Private Equity Firms?

It always looked like but no one cared. Gordon Gekko argued along ago greed is good and has remained a dictum for the financial sector.

Now a new research by Profs Victoria Ivashina and Josh Lerner of HBS shows greed rules Private Equity firms. Here is a discussion of the same:

In a first-ever look at the internal economics driving private equity partnerships, Harvard Business School researchers have found that many of these funds can be torn apart by greed among founding partners who take home a much bigger share of profits than other senior partners, even when their performance doesn’t merit higher rewards.

This creates a ripple effect, where other senior partners become resentful, disenchanted, and leave their jobs, causing instability that spooks potential investors and could lead to a firm’s collapse. This pattern of unequal pay was much more extensive than anticipated among the 717 private equity partnerships studied by HBS finance professor Victoria Ivashina and Josh Lerner, the Jacob H. Schiff Professor of Investment Banking.

These rifts, far from being uncommon, are the average experience in PE partnerships, Ivashina says.

In their working paper released in March, Pay Now or Pay Later? The Economics within the Private Equity Partnership, she and Lerner found that a partner’s pay was often tied more to the person’s status than to performance. Previous success as an investor seemed to have little bearing on how much the partner earned. Founders in particular gobbled up a much bigger piece of the pie.

Senior partners who believe they aren’t compensated fairly are significantly more likely to leave a firm. These departures can give limited partners the impression that a private equity firm is unstable. That perception creates a wariness to invest, which means a PE firm often struggles in its attempts to raise the next fund.

So in essence, founding partners are damaging their own firms, in some cases beyond repair, by being greedy.

One still needs research to prove the obvious..

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