Peer versus Pure Benchmarks in the Compensation of Mutual Fund Managers
59 Pages Posted: 24 Aug 2019 Last revised: 24 Mar 2021
Date Written: March 16, 2020
We examine the role of peer (Lipper manager indices) vs. pure (S&P 500) benchmarks in fund manager compensation. We first model the impact of peer vs. pure benchmarks on manager incentives and then test the model’s predictions using a unique hand-collected dataset. We find that 71% of managers are compensated solely or partially based on peer benchmarks. Consistent with the model, funds with peer-benchmarked managers exhibit higher active share, abnormal performance, and advisory fees than those with pure-benchmarked managers. Analyzing investment advisors’ choice between benchmark types, we find peer-benchmarking advisors have more sophisticated investors with greater performance sensitivity and are more likely to sell through the direct channel, suggestive of market segmentation.
Keywords: mutual funds, fund manager, managerial compensation, incentives, benchmarking, peer benchmarks, closet indexing
JEL Classification: G11, G23, J33, J44
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