Indirect Incentives of Hedge Fund Managers

46 Pages Posted: 22 Mar 2013 Last revised: 25 Feb 2021

See all articles by Jongha Lim

Jongha Lim

California State University, Fullerton - Department of Finance

Berk A. Sensoy

Vanderbilt University - Finance

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2013

Abstract

Indirect incentives exist in the money management industry when good current performance increases future inflows of new capital, leading to higher future fees. We quantify the magnitude of indirect performance incentives for hedge fund managers. Flows respond quickly and strongly to performance; lagged performance has a monotonically decreasing impact on flows as lags increase up to two years. Conservative estimates indicate that indirect incentives for the average fund are four times as large as direct incentives from incentive fees and returns to managers' own investment in the fund. For new funds, indirect incentives are seven times as large as direct incentives. Combining direct and indirect incentives, for each dollar generated for their investors in a given year, managers receive close to another dollar in direct performance fees plus the present value of future fees over the expected life of the fund. Older and capacity constrained funds have considerably weaker relations between future flows and performance, leading to weaker indirect incentives. There is no evidence that direct contractual incentives are stronger when market-based indirect incentives are weaker.

Suggested Citation

Lim, Jongha and Sensoy, Berk A. and Weisbach, Michael S., Indirect Incentives of Hedge Fund Managers (March 2013). NBER Working Paper No. w18903, Available at SSRN: https://ssrn.com/abstract=2237816

Jongha Lim (Contact Author)

California State University, Fullerton - Department of Finance ( email )

PO Box 34080
Fullerton, CA 92834-9480
United States

Berk A. Sensoy

Vanderbilt University - Finance ( email )

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Nashville, TN 37203
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Michael S. Weisbach

Ohio State University (OSU) - Department of Finance ( email )

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Columbus, OH 43210-1144
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National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI) ( email )

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