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Management Science Vol. 69 No. 10 2023

A Theory of Liquidity in Private Equity

Vincent Maurin1; David T. Robinson2,3; Per Strömberg1,4,5

1 Stockholm School of Economics, Swedish House of Finance, 11160 Stockholm, Sweden; · 2 Fuqua School of Business, Duke University, Durham, North Carolina 27708 · 3 National Bureau of Economic Research, Cambridge, Massachusetts 02138; · 4 Centre for Economic Policy Research, London EC1V0DX, United Kingdom; · 5 European Corporate Governance Institute, c/o the Royal Academies of Belgium, 1000 Brussels, Belgium

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.

DOI
10.1287/mnsc.2022.4612
Volume
69
Issue
10
Pages
5740-5771
Language
en
Sources
openalex bibtex:phds-export.bib crossref

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