An Option-Pricing Framework for the Valuation of Fund Management Compensation

Abstract

Compensation of funds managers increasingly involves elements of profit sharing that entitle managers to option-like payoffs. An important example is the compensation of private equity fund managers. Compensation of private equity fund managers typically consists of a fixed management fee and a performance-related carried interest. The fixed management fee resembles common compensation terms of mutual funds and hedge funds, while the performance-related carried interest is uncommon among most mutual funds. Moreover, the performance-related carried interest typically differs from variable hedge fund fees. In this chapter, we derive the value of the variable components of private equity fund managers’ compensation based on a risk-neutral option-pricing approach.

Citation

Buchner, A., Mohamed, A. and Wagner, N. (2012), "An Option-Pricing Framework for the Valuation of Fund Management Compensation", Batten, J.A. and Wagner, N. (Ed.) Derivative Securities Pricing and Modelling (Contemporary Studies in Economic and Financial Analysis, Vol. 94), Emerald Group Publishing Limited, Leeds, pp. 331-350. https://doi.org/10.1108/S1569-3759(2012)0000094016