While the business model of private equity has remained largely unchanged since the 1980s, private equity as an industry has undergone a dramatic transformation. In the early 1980s, private equity was both highly profitable and highly controversial. Today, on the other hand, it is an important asset class and its returns are modest. This paper will document both of these changes and identify the several factors that contributed simultaneously to private equity’s declining profitability and to its increasing public acceptance. This paper will also identify another change that private equity underwent in the 1980s, which has been largely ignored: the change in how private equity fund managers are compensated. The change in manager compensation had a material impact on the industry. While heralded as unequivocally positive for private equity investors, these compensation terms created new agency costs between investors and private equity managers and contributed to the increasing significance of fixed compensation in private equity.
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