Determinants of Hedge Fund Internal Controls and Fees
Joseph J. Gerakos
Tuck School of Business at Dartmouth College
Chicago Booth Research Paper No. 09-44
Chicago Booth Initiative on Global Markets Working Paper No. 46
We investigate the determinants of hedge fund internal controls and their association with the fees that funds charge investors. Hedge funds are subject to minimal regulation. Hence, hedge fund managers voluntarily implement internal controls, and managers and investors freely contract on fees. We find that internal controls are stronger in funds with higher potential agency costs. Further, internal controls are stronger in funds domiciled in jurisdictions that provide investors with limited legal redress for fraud and financial misstatements. Short selling funds, however, are more likely to protect information of their investment positions by implementing weaker internal controls that limit external oversight. With respect to fees, we find that the percentage of positive profits that the manager receives increases in the strength of the fund’s internal controls. Finally, removing the manager from setting and reporting the fund’s official net asset value, along with reputational incentives and monitoring by leverage providers, are all associated with lower likelihoods of future regulatory investigations of fraud and/or financial misstatement.
Number of Pages in PDF File: 61
Keywords: hedge funds, internal controls, investor fees, restatements
JEL Classification: D82, J33, G20, G34, M41, M49
Date posted: September 18, 2008 ; Last revised: November 16, 2011
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