How Private Is Private Equity, and at What Cost?

The literature on private equity ignores the impact of the securities laws. This is an oversight: key facets of private-equity structure (in particular, the limited control, liquidity, and information rights that are typical of limited partner investors) can be explained as an attempt to escape the reach of securities antifraud rules. The benefit of circumventing these rules is that doing so prevents the unwinding of optimal risk allocation between general and limited partners that would otherwise occur. This does, however, come at a significant cost, which is the exacerbation of agency costs between limited partner investors and the general partner manager; this necessitates the massive performance-based compensation that general partners receive, which is inefficient from a first-best perspective. Hence, reforming the securities laws would benefit not just public companies, but also private equity.