New Publication: Investment Game in Private Equity

Our partner Mika J. Lehtimäki has analysed international private equity contracting and dynamics from the perspective of law and game theory. The paper is part of the working paper series of the National University of Singapore, Centre for Banking & Finance Law (CBFL). The paper will also be published in another international publication soon. We hope the analysis assists out Clients and Colleagues with their fund investing and asset management work. The papercan be downloaded here.


Private equity investing and the relationship between the general partner and the limited partners are plagued with the risk of information asymmetries and agency costs, so the markets have developed several mechanisms to align the incentives of the funds and the investors, most importantly through disclosure requirements and protections in limited partnership agreements. However, such agreements may not always deal with the most important asymmetries or agency conflicts, especially the hidden effort problem. From the fund’s perspective, there are also other relationships that affect its internal dynamics. They are the need for interest alignment between the fund (and the general partner) and the managers of the portfolio companies, the risk of financial agency costs and the risk of strategic creditor actions. All of these relationships are regulated primarily by contracts. In this paper, I evaluate the game-theoretical framework, Investment Game, based on the analysis of the general-limited partner investment-effort relationship supported by a brief analysis of the other relationships. I argue that, in most cases, the limited partners are able to solve the general partner effort maximisation problem, making part of the fund regulation unnecessary. However, private ordering may not work in some cases. Despite these situations, the Investment Game enables, even when the limited partners cannot affect the fund terms, an analysis of the general partner effort level and the level of undisclosed private benefits. Therefore, the Investment Game also sets a framework for a data analysis of private equity investing.