Pay for performance from future fund flows: The case of private equity. Review of Financial Studies 25:3259–3304

Lifetime incomes of private equity general partners (GPs) are affected by their current funds ’ performance not only directly, through carried interest profit-sharing provisions, but also indirectly by the effect of the current fund’s performance on GPs ’ abilities to raise capital for future funds. In the context of a rational learning model, which we show better matches the empirical relations between future fund-raising and current performance than behavioral alternatives, we estimate that indirect pay for performance from future fund-raising is of the same order of magnitude as direct pay for performance from carried interest. Consistent with the learning framework, indirect pay for performance is stronger when managerial abilities are more scalable and weaker when current performance is less informative about ability. Specifically, it is stronger for buyout funds than for venture capital funds, and declines in the sequence of a partnership’s funds. Total pay for performance in private equity is both considerably larger and much more heterogeneous than implied by the carried interest alone. Our framework can be adapted to estimate indirect pay for performance in other asset management settings. (JEL G11, G23, J33