These empirical findings deserve some detailed thoughts. First, the fact that net of fees, returns from private equity investment are (on average) not any better than a market benchmark means that some general partners are getting undeserved fees. In the private equity industry, the compensation scheme is quite homogeneous and does not vary widely. Compensation is generally made up of an annual management fee (between 1, 5 and 2 % of the fund) and 20 % share of the profit. A 20 % share of the profit is a high fee when you do not deliver absolute return (i.e., getting 20 % when you are not able to do better than the market is probably too high). Second, the large variability in managerial skills together with the persistence in returns mean that free entry is needed to lower the high fee margins. Last, if it is puzzling that true performers cannot capture a higher compensation from their differentiated skill. Why is there not a separated equilibrium in which general partners are compensated according to performance?
Still this is a young industry and two decades might not provide enough data for a sector that requires lock up periods of around ten years.

* Steven Kaplan of the University of Chicago and Antoinette Schoar
Private Equity Performance, National Bureau of Economic Research Working Paper 9807, June 2003, www.nber.org.

Deals in US during the last quarter of 2006
Source: Thomson Financial