Agency Costs of Dry Powder in Private Equity Funds

We model the fee collection of private equity sponsors and show that funds tend to underlever future deals when they accumulate substantial amounts of dry powder at the end of the investment period, and that in order to increase revenues from fees. Our empirical analysis, which covers 386 funds sponsoring 1,812 US LBO deals over the period 1980–2021, supports our theoretical modelling on leverage and shows that this situation is associated with investment distortions and poorer performance at both the deal and fund level. Our results are grounded in agency theory.