2010 • Volume 35 • Number 1

A Critical Theory of Private Equity

Lee Harris

In the private equity world, partnership agreements have received praise from many corners for reducing the agency costs arising between the interests of fund managers and investors. This article sets out to assess contract design in private equity partnerships. The argument here is that the importance of many of these heralded contract design features has been overstated. Part II describes the legal rights of investors in private equity funds. By default, investors in private limited partnerships have limited rights to participate in day-to-day operations or challenge decisions of fund managers. As a result of this set of default legal rules, investors in these funds face a familiar agency problem. That is, fund managers may be emboldened to pursue their own self-interest at the expense of investor interests. Some have boasted that contract design resolves many of these major agency problems. Parts III and IV describe a few of the best private contractual arrangements that investors have used to overcome these legal and economic constraints. As will be shown, however, many of these contract design features have severe shortcomings. Contract design appears to be an uncertain solution to the problem of agency costs in private equity limited partnerships.