Incomplete Contracts, Price, and Quality: Hedge Funds' Fees and Performance

Abstract

When sellers set the price for ex-ante unobservable and ex-post unenforceable quality, price signals credence quality. Hedge funds resemble incomplete long-term contracts for credence goods under buyer-determined auctions. I show that hedge funds' ability to solicit investments at higher management fees signals their capacity to generate higher net returns. This result is more pronounced during bust cycles and closer to financial hubs, i.e., when management quality signaling is more valuable.

Keywords: Pricing and Performance, Incomplete Contracts, Reciprocity, Hedge Funds

JEL Classification: L14, L15, G11, G41