The Optimal Size of Hedge Funds: Conflict between Investors and Fund Managers

61 Pages Posted: 9 Aug 2012 Last revised: 25 Nov 2015

See all articles by Chengdong Yin

Chengdong Yin

Purdue University - Krannert School of Management

Date Written: November 24, 2015

Abstract

This study examines whether the standard compensation contract in the hedge fund industry aligns managers’ incentives with investors’ interests. I show empirically that managers’ compensation increases when fund assets grow, even when diseconomies of scale in fund performance exist. Thus, managers’ compensation is maximized at a much larger fund size than is optimal for fund performance. However, to avoid capital outflows, managers are also motivated to restrict fund growth to maintain style-average performance. Similarly, fund management firms have incentives to collect more capital for all funds under management, even at the expense of fund performance, including their flagship funds.

Keywords: Hedge Fund, Optimal Size, Conflict of Interest, Incentive

JEL Classification: G20, G23, G29

Suggested Citation

Yin, Chengdong, The Optimal Size of Hedge Funds: Conflict between Investors and Fund Managers (November 24, 2015). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2126689 or http://dx.doi.org/10.2139/ssrn.2126689

Chengdong Yin (Contact Author)

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

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