High-Water Marks and Hedge Fund Management Contracts

Posted: 30 Nov 2003

See all articles by William N. Goetzmann

William N. Goetzmann

Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)

Jonathan E. Ingersoll

Yale School of Management - International Center for Finance

Stephen A. Ross

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance

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Abstract

Incentive fees for money managers are frequently accompanied by high-water mark provisions that condition the payment of the performance fee upon exceeding the previously achieved maximum share value. In this paper, we show that hedge fund performance fees are valuable to money managers, and conversely, represent a claim on a significant proportion of investor wealth. The high-water mark provisions in these contracts limit the value of the performance fees. We provide a closed-form solution to the cost of the high-water mark contract under certain conditions. Our results provide a framework for valuation of a hedge fund management company.

Suggested Citation

Goetzmann, William N. and Ingersoll, Jonathan E. and Ross, Stephen A., High-Water Marks and Hedge Fund Management Contracts. Journal of Finance, Vol. 58, pp. 1685-1718, August 2003. Available at SSRN: https://ssrn.com/abstract=424757

William N. Goetzmann (Contact Author)

Yale School of Management - International Center for Finance ( email )

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National Bureau of Economic Research (NBER)

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Jonathan E. Ingersoll

Yale School of Management - International Center for Finance ( email )

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Stephen A. Ross

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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203-432-8931 (Fax)

Yale University - International Center for Finance

Box 208200
New Haven, CT 06520-8200
United States

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