Harvard Case - Oregon Public Employees Retirement Fund: Push and Pull Over GP/LP Compensation
"Oregon Public Employees Retirement Fund: Push and Pull Over GP/LP Compensation" Harvard business case study is written by Susan Chaplinsky, Elena Loutskina, Rob Walsh. It deals with the challenges in the field of Entrepreneurship. The case study is 18 page(s) long and it was first published on : Aug 8, 2011
At Fern Fort University, we recommend that the Oregon Public Employees Retirement Fund (OPERS) adopt a more nuanced approach to GP/LP compensation, focusing on aligning incentives with long-term performance and incorporating a greater degree of transparency and accountability. This approach involves a multi-pronged strategy that includes:
- Shifting towards performance-based compensation: OPERS should move away from fixed fees and towards a compensation structure that rewards GPs based on the fund?s long-term performance. This could involve profit-sharing arrangements, carried interest tied to specific performance benchmarks, or a combination of both.
- Introducing a tiered fee structure: OPERS should consider implementing a tiered fee structure that varies based on the fund?s performance. This would incentivize GPs to strive for higher returns and demonstrate their commitment to generating value for the fund.
- Enhancing transparency and accountability: OPERS should implement robust reporting mechanisms that provide clear and detailed information about GP compensation, fund performance, and investment strategies. This will enable OPERS to effectively monitor and evaluate GPs and ensure that their actions are aligned with the fund?s objectives.
- Investing in data analytics and technology: OPERS should invest in data analytics and technology to improve its ability to track and analyze GP performance, identify potential conflicts of interest, and make informed decisions about compensation.
2. Background
The case study focuses on the Oregon Public Employees Retirement Fund (OPERS), a public pension fund facing challenges in managing its investment portfolio. The fund?s investment strategy relies heavily on private equity, with a significant portion of its assets allocated to limited partnerships (LPs). However, OPERS is concerned about the high fees charged by general partners (GPs) and the lack of transparency in their compensation structures.
The main protagonists in the case study are:
- OPERS Board of Trustees: The board is responsible for overseeing the fund?s investments and ensuring that they are managed in a responsible and ethical manner. They are concerned about the high fees charged by GPs and the lack of transparency in their compensation structures.
- General Partners (GPs): The GPs manage the private equity funds on behalf of OPERS. They are responsible for making investment decisions and generating returns for the fund. They argue that their high fees are justified by their expertise and ability to generate high returns.
- Limited Partners (LPs): OPERS is the limited partner in these private equity funds. They provide the capital for the investments but have limited control over the investment decisions.
3. Analysis of the Case Study
The case study highlights the complex relationship between GPs and LPs in the private equity industry. OPERS, as the LP, faces a dilemma: how to ensure that its investments are managed effectively while also ensuring that GPs are fairly compensated for their expertise and effort.
Key issues:
- Misaligned incentives: The traditional fee structure for GPs, based on fixed management fees and carried interest, can create misaligned incentives. GPs may prioritize short-term gains over long-term value creation, potentially jeopardizing the fund?s long-term performance.
- Lack of transparency: The lack of transparency in GP compensation structures can make it difficult for LPs to evaluate the fairness and effectiveness of the fees. This can lead to a lack of trust and accountability.
- Limited bargaining power: LPs often have limited bargaining power in negotiating with GPs, particularly when dealing with large and established firms. This can result in unfavorable compensation arrangements for LPs.
Frameworks used:
- Agency Theory: This theory helps understand the conflict of interest between the principal (OPERS) and the agent (GP). The theory suggests that GPs, as agents, may not act in the best interests of the principal if their incentives are not aligned.
- Principal-Agent Problem: This framework highlights the challenges of monitoring and controlling the actions of agents (GPs) when they have access to information and resources that the principal (OPERS) does not.
- Game Theory: This framework can be applied to analyze the strategic interactions between GPs and LPs. Understanding the incentives and payoffs for each player can help OPERS develop strategies to negotiate more favorable compensation arrangements.
4. Recommendations
To address the challenges outlined above, OPERS should implement the following recommendations:
Short-Term:
- Negotiate performance-based fees: OPERS should actively negotiate with GPs to incorporate performance-based fees into their compensation structures. This could involve a tiered fee structure, where fees increase with higher returns, or a profit-sharing arrangement, where GPs receive a portion of the fund?s profits.
- Improve transparency and disclosure: OPERS should demand greater transparency from GPs regarding their compensation structures, investment strategies, and performance metrics. This could involve requiring GPs to provide detailed reports on their fees, expenses, and investment decisions.
- Develop a robust due diligence process: OPERS should implement a rigorous due diligence process for selecting GPs, focusing on their track record, experience, and alignment with the fund?s long-term objectives.
Long-Term:
- Invest in data analytics and technology: OPERS should invest in data analytics and technology to improve its ability to track and analyze GP performance, identify potential conflicts of interest, and make informed decisions about compensation.
- Promote competition and innovation: OPERS should explore ways to promote competition and innovation in the private equity market. This could involve diversifying its investment portfolio by investing in emerging managers, smaller firms, or alternative investment strategies.
- Develop a strategic partnership framework: OPERS should develop a strategic partnership framework with GPs that emphasizes long-term value creation and alignment of incentives. This could involve establishing clear performance benchmarks, regular performance reviews, and a mechanism for resolving disputes.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: The recommendations align with OPERS?s mission to provide secure and sustainable retirement benefits for its members. By promoting long-term value creation and transparency, OPERS can ensure that its investments are managed effectively and that its members? interests are protected.
- External customers and internal clients: The recommendations consider the needs of both external customers (OPERS members) and internal clients (OPERS staff). By improving the fund?s performance and transparency, OPERS can enhance its reputation and build trust with its stakeholders.
- Competitors: The recommendations consider the competitive landscape in the private equity industry. By promoting innovation and competition, OPERS can ensure that it is able to secure favorable terms from GPs and achieve its investment objectives.
- Attractiveness ? quantitative measures if applicable: The recommendations are expected to have a positive impact on the fund?s long-term performance by aligning incentives, promoting transparency, and improving the effectiveness of its investment management.
- Assumptions: The recommendations assume that OPERS has the resources and expertise to implement the proposed changes. It also assumes that GPs are willing to negotiate and adapt their compensation structures to align with OPERS?s objectives.
6. Conclusion
The case study of the Oregon Public Employees Retirement Fund highlights the importance of aligning incentives and promoting transparency in the relationship between GPs and LPs. By adopting a more nuanced approach to GP/LP compensation, OPERS can ensure that its investments are managed effectively and that its members? interests are protected. This involves shifting towards performance-based compensation, introducing a tiered fee structure, enhancing transparency and accountability, and investing in data analytics and technology.
7. Discussion
Alternatives not selected:
- Complete divestment from private equity: This option would involve OPERS completely withdrawing its investments from private equity. While this would eliminate the concerns about GP compensation, it would also limit the fund?s access to potentially high-performing investments.
- Maintaining the current status quo: This option would involve OPERS continuing its current approach to GP/LP compensation. However, this would perpetuate the existing challenges of misaligned incentives and lack of transparency.
Risks and key assumptions:
- GP resistance: GPs may resist changes to their compensation structures, particularly if they perceive them as unfair or detrimental to their interests.
- Complexity of implementation: Implementing the proposed changes will require significant effort and resources from OPERS.
- Limited impact on performance: The proposed changes may not necessarily lead to immediate improvements in the fund?s performance.
8. Next Steps
To implement the recommendations, OPERS should take the following steps:
- Develop a detailed implementation plan: This plan should outline the specific actions to be taken, the timeline for implementation, and the resources required.
- Engage with GPs: OPERS should engage in open and transparent discussions with GPs to explain the rationale for the proposed changes and to negotiate mutually acceptable terms.
- Monitor and evaluate: OPERS should establish a robust monitoring and evaluation framework to track the impact of the changes on the fund?s performance and to identify any areas for improvement.
- Communicate with stakeholders: OPERS should communicate its plans and progress to its members, staff, and other stakeholders to build trust and transparency.
By taking these steps, OPERS can effectively address the challenges of GP/LP compensation and ensure that its investments are managed in a responsible and sustainable manner.
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Case Description
The case is designed to explore the structure and rationale behind the standard compensation arrangements in the private equity (PE) industry. It effectively introduces students to commonly used terms of limited partnership agreements (LPAs), such as fees, carried interest, and preferred terms or hurdle rates. The backdrop for the Oregon Public Employees Retirement Fund (OPERF) case is the changed market conditions following the 2007 financial crisis that spurred a reevaluation of the basic terms of LPAs across the PE industry. This case has been taught in a second-year elective course on entrepreneurial finance and private equity and would be suitable for similarly focused courses on venture capital, private equity, or entrepreneurship. The case can also be used in an investment class designed to explore private equity as an asset class.
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