The Quality-Assuring Role of Mutual Fund Advisory Fees
Michel A. Habib
University of Zurich; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute
D. Bruce Johnsen
George Mason University - School of Law; PERC - Property and Environment Research Center
February 20, 2015
George Mason Law & Economics Research Paper No. 12-64
Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager’s one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.
Number of Pages in PDF File: 44
Keywords: excessive fees, advisory fees, quality-assurance, open-access, closet indexing
JEL Classification: D23, D86, G23, L22
Date posted: September 30, 2012 ; Last revised: February 25, 2015
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