Incentives from Compensation Option and Risk-Taking - Hedge Funds

Abstract:     
With a new proxy for the compensation option to hedge funds management, we explore the managerial incentives and risk-taking behavior for an extended sample of hedge funds. We focus on the incentives in response to the compensation option as discussed in Goetzmann, Ingersoll, and Ross (2003), and to relative performance in a 'tournament' as proposed by Brown, Harlow, and Starks (1996). We find that managers do respond to the "moneyness" of their compensation option and the length of time a fund has stayed under-water by shifting their volatility strategies. We find that size, age, as well as management fee level all play a role in affecting this response. On the other hand, funds are also found to respond to relative performance as described in the 'tournament' theory.

Keywords: managerial incentive, option

JEL Classification: G11, G12

working papers series