High-Water Marks and Hedge Fund Management Contracts
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
Jonathan E. Ingersoll Jr.
Yale School of Management - International Center for Finance
Stephen A. Ross
Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance
Journal of Finance, Vol. 58, pp. 1685-1718, August 2003
Incentive fees for money managers are frequently accompanied by high-water mark provisions that condition the payment of the performance fee upon exceeding the previously achieved maximum share value. In this paper, we show that hedge fund performance fees are valuable to money managers, and conversely, represent a claim on a significant proportion of investor wealth. The high-water mark provisions in these contracts limit the value of the performance fees. We provide a closed-form solution to the cost of the high-water mark contract under certain conditions. Our results provide a framework for valuation of a hedge fund management company.
Accepted Paper Series
Date posted: November 30, 2003
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