Private Equity Managers Take Less Risk When More of Their Own Money Is on the Line

They also take on more debt, researchers find.

Illustration by Claire Merchlinsky

Illustration by Claire Merchlinsky

Private equity managers with “skin in the game” may be more cautious investors — depending on how much of their personal wealth is at stake, according to researchers from the Norwegian School of Economics and Goethe University Frankfurt.

General partners who’ve sunk large proportions of their own wealth into their private equity funds tend to invest in less risky portfolio companies versus peers with less personally at stake, authors Carsten Bienz, Karin Thorburn, and Uwe Walz found in a new study.

The three authors focused their research on 120 private equity professionals in Norway because tax returns are public in that country, making it possible to collect data on mangers’ taxable wealth. The average investment professional’s fund stake accounted for 89 percent of their taxable wealth, or 47 percent for the median investor. At the partner level, fund ownership amounted to 93 percent of taxable wealth on average, or 48 percent at the median.

Higher fund stakes relative to a private equity manager’s personal net worth linked to lower equity beta in portfolio companies and more diversified portfolios, Bienz, Thornburn, and Walz found from the sample. The results factored in the “commonly accepted” assumption that relatively poor individuals are more risk averse than their wealthier peers.

“This evidence suggests that the incentive effect of the GP’s ownership is not limited to characteristics of the individual target firms, but has a broader impact on the overall design of the fund portfolio,” the authors wrote.

[II Deep Dive: Hedge Fund Managers With ‘Skin in the Game’ Outperform — But They’re Also Less Likely to Take Your Money]


They also found that general partners with higher proportions of personal capital at stake used more debt in portfolio company acquisitions — a trend they attributed to the fact that the portfolio companies being bought out were less risky. “Since lower-risk firms have greater debt capacity, GP ownership also has an indirect effect on leverage,” the authors wrote.

Based on this evidence, Bienz, Thornburn, and Walz suggested that outside investors in private equity funds (LPs) could incentivize their managers to take less risk by requiring them to invest their own capital. “LPs ultimately care for the risk-adjusted return net of fees,” they noted. “Whether this reduction in risk appetite is optimal or not goes beyond the scope of this paper.”