Finance Seminar with Per Strömberg, Stockholm School of Economics

The Department of Finance is proud to announce the upcoming seminar with Per Strömberg, Stockholm School of Economics.

Per Strömberg will present:

A Theory of Liquidity in Private Equity

ABSTRACT
We propose an optimal contracting model of Private Equity (PE) that can rationalize many empirical patterns in fundraising, fund structure, and returns. General partners (GPs) possess superior investment skills and raise capital from Limited Partners (LPs) to finance illiquid projects. The optimal contract incentivizes GPs to maximize investment payoffs by giving them a profit share in the fund, while compensating LPs for liquidity risk. Fund size increases with the amount of wealth the GP can co-invest in the fund. When LP demand increases, GPs keep performance fees constant but increase fund size. GPs may inefficiently accelerate investment to ensure that LPs honor their funding commitment. In markets with low liquidity risk for LPs, net fund returns are lower, and aggregate fundraising and fund sizes are larger. LPs with a lower cost of illiquidity have access to better-performing funds and realize higher returns. In the secondary market, LP partnership claims trade at a discount to fundamentals when aggregate liquidity is scarce. Introducing a secondary market can increase the size of the primary market by enabling LPs with higher illiquidity costs to invest in PE. This effect can be reversed when LPs with lower illiquidity cost choose to focus on the secondary market.