Incentive Compensation at Harvard Management Company

1
Incentive Compensation at Harvard Management
Company
Fall 2006 Venture Capital and Private Equity
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
2
Recap of Last Class
Fall 2006 Venture Capital and Private Equity

• Preferred return may help align incentives
• By reducing share of compensation as capital
  gains, may be tax-inefficient
• Details about industry characteristics are
  necessary to understanding the contract

Victor Fleischer ASSOCIATE PROFESSOR OF LAW
3
VC/PE vs. Hedge Funds
Fall 2006 Venture Capital and Private Equity

• Harvard Mgmt Co operates more like a hedge fund
  than a fund-of-funds with a single client (Yale)
• Takes positions in liquid securities
• Income generated is mostly ordinary income /
  short-term capital gain, so tax impact of
  preferred return isnt important

Victor Fleischer ASSOCIATE PROFESSOR OF LAW
4
Harvard Endowment
Fall 2006 Venture Capital and Private Equity
Harvard
HMC
Trust Endowment
Relatively Small Allocation
VC Fund
PE Fund
Relatively Large Allocation
Long
Short
e.g., Emerging Market Futures (Index)
Portfolio Company
Portfolio Company
Portfolio Company
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
5
Design of Incentive Compensation
Fall 2006 Venture Capital and Private Equity

• Base Salary - 200,000
• Neutral Bonus - 100,000
• Incentive Bonus - 500,000 per 100 bps
• 30 subject to clawback next year
• Max incentive comp?
• What incentives does this provide?
• What is the managers attitude toward risk?

Victor Fleischer ASSOCIATE PROFESSOR OF LAW
6
What Does This Resemble?
Fall 2006 Venture Capital and Private Equity

• Cash
• Common Stock
• Call Option
• At the money
• In the money
• Indexed Option
• Profits interest in a partnership?
• Capital interest in a partnership?

Victor Fleischer ASSOCIATE PROFESSOR OF LAW
7
Fall 2006 Venture Capital and Private Equity
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
8
Fall 2006 Venture Capital and Private Equity
HMC Payout
2.8
2.3
1.8
Payout
800
300
200
0
5
0
-2
10
6
9
Return (assuming 5 benchmark)
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
9
Fall 2006 Venture Capital and Private Equity
HMC Payout
2.8
2.3
1.8
Payout
800
300
200
0
-5
-10
-12
0
-4
-1
Return (assuming -5 benchmark)
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
10
Protests
Fall 2006 Venture Capital and Private Equity

• Donors
• Distributive Justice
• Janitors
• Professors
• Students
• Optics issue
• Swensen

Victor Fleischer ASSOCIATE PROFESSOR OF LAW
11
Big Payouts
Fall 2006 Venture Capital and Private Equity

• 18 Million to David Mittleman in 2004-05
• 16.9 Million Maurice Samuels in 2004-05
• HMC CEO Jack Meyer
• Professors 150,000 - 300,000
• Top profs still lt 1,000,000

Quit
Victor Fleischer ASSOCIATE PROFESSOR OF LAW
12
Next Class
Fall 2006 Venture Capital and Private Equity

• Agency Costs
• Bankman Cole
• Acme case

Victor Fleischer ASSOCIATE PROFESSOR OF LAW