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INSEAD Working Paper 2014/57/FIN
We investigate an informal yet important mechanism in the private equity industry that helps to reduce uncertainty: relationship building. Based on a large sample of private equity funds over the 1980-2010 period, we find that the general partners strategically allocate good funds to loyal investors, who in turn commit to invest also in new funds that are not ex-ante promising. In addition, this effect is stronger for venture capital (VC) funds and more popular among certain types of investors. The bargaining power of the relationship concentrates in the hand of GPs.