The Promise of Hedge Fund Governance: How Incentive Compensation Can Enhance Institutional Investor Monitoring
57 Pages Posted: 24 Apr 2009 Last revised: 1 Jun 2009
Date Written: 2008
Progressive legal scholars argue that institutional investors should play a greater role in disciplining corporate managers. These reformers seek to harness the talent and resources of mutual funds and public pension funds to increase managerial accountability to shareholder interests. Conservative scholars respond that empowering institutional investors would do little more than relocate the underlying agency costs. Although shirking by corporate managers might indeed be reduced, institutional investors suffer from their own set of agency problems and so would need their own monitor. Ultimately, someone must watch the watchers.
This Article argues that neither corporate managers nor institutional investors are properly incentivized to serve shareholder interests. Therefore, neither is appropriately positioned to serve as the ultimate decision maker. A better model of governance is the incentive fee structure employed by hedge funds and other private equity funds. If institutional fund managers were permitted to adopt a similar compensation scheme, their interests and the interests of their investors would merge. As a result, they would be transformed into ideal servants of shareholder interests, capable of bringing much-needed discipline to corporate America.
Keywords: hedge fund, private equity, institutional investor, monitor, executive compensation, corporate governance
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