Private equity investing and the leveraged buy-outs are plagued with the risk of agency costs, so the markets have developed several mechanisms to align the incentives of the funds and the investors. However, the limited partnership agreements do not in practice deal effectively with the most important agency costs, the investment periods are long and fund disclosure may not be supported by sufficient remedies.

There are two additional relationships that affect the incentives and dynamics of private equity funds. The first is the need for interest alignment between the fund (and the GP) and the managers of the portfolio companies. The second is the risk of financial agency costs and strategic creditor actions between the fund and portfolio companies and the creditors of an LBO arrangement. Also these relationships are primarily governed by contracts.

When these three relationships are evaluated together, we can see that the private equity funds tend to opt for a ‘risk-allocation space’ that optimises their risk-return, while controlling for both the investor-run-out scenario, negative cash-flow decisions by the managers and strategic creditor actions and control in a default scenario. The research builds on a formal mathematical analysis of dynamic games of incomplete and imperfect information in these three relationships. Based on the formal framework, the research evaluates fund regulation in the UK, Luxembourg and Singapore and how they deal with this comprehensive view on private equity. The research aims to provide formal and practical solutions to the agency conflicts surrounding private equity contracting. The research also addresses the question whether national regulation-based regimes should be enhanced. The objective is to give national regulators and actors tools to make regulatory regimes and contractual frameworks more competitive and sound while dealing with the systemic and transparency risks inherent in the ‘risk allocation space’.