Agency costs of dry powder in private equity funds

The amount of non-invested capital in the private equity industry (dry powder) has raised numerous concerns from public opinion. Our paper gives evidence that the accumulation of an excess cash by the fund (“dry powder”) at the end of the investment period might induce investment distortions rendering the contracts between the General Partner and the Limited Partners inefficient ex post. We perform an empirical analysis of 383 funds sponsoring 1,011 US LBO deals over the period 1980 – 2019. High levels of dry powder are associated with under-utilization of leverage and larger deals with less syndication. These deals reach a significant lower cash on cash return. This drag on performance is also found at fund level. Our interpretation is that funds with high levels of dry powder at the end of the investment period are subject to pressure to spend the dry powder, which gives rise to agency costs. Our results are consistent with GPs focusing more on maximizing their fees rather than maximizing the value for LPs.