How private equity investments can be made more effective through game theory analysis

What is it about?

Private equity investing and the relationship between the fund manager and the investors are plagued with the risk of information asymmetries and agency costs. The so-called limited partnership agreements governing their relationship do not deal adequately with such problems . From the fund’s perspective, however, there are also other important relationships, such as those with the creditors and he managers of the fund. All of these relationships are regulated primarily by contracts. In the paper, I evaluate a game-theoretical framework called the Investment Game, which is able to analyse these relationships in a formal way while at the same time taking into consideration the existing fund regulation. The Investment Game shows that the investors are able to solve the fund manager's effort maximisation problem making part of the fund regulation unnecessary. The Investment Game also enables, even when the investors cannot affect the fund terms, an analysis of the fund manager's effort level and the level of undisclosed private benefits. The analysis, therefore, sets a framework for a data analysis of private equity investing.

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Photo by Hassan Pasha on Unsplash

Photo by Hassan Pasha on Unsplash

Why is it important?

The level of assets and funds held and employed globally by private equity funds is very large. The problems associated with the fiduciary obligations, market transparency, income and ownership of the investors, e.g. pension insurance companies, wealth funds etc., are pressing legally, ethically and financially. The way of addressing these problems affect the wealth and income of a large part of the population. The analysis sets the basis for ensuring the systemic aspects of fund investing can be controlled in a better way.

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