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Alternative Market Briefing

Academics find that each dollar of performance leads to disproportionately more dollars in future revenue

Thursday, March 21, 2013

Beverly Chandler, Opalesque London: Academics Jongha Lim from the University of Missouri, Berk A. Sensoy and Michael S. Weisbach from The Ohio State University have written a paper for the Charles A. Dice Center for Research in Financial Economics on Indirect Incentives of Hedge Fund Managers.

The authors set out to discover the size and effect of indirect performance incentives for hedge fund managers. Hedge fund managers are among the most highly paid individuals today, the authors write. "According to Kaplan and Rauh (2010), the top five hedge fund managers likely earned more than all 500 CEOs of S&P 500 firms in 2007. Therefore, the payoff to becoming a top hedge fund manager is enormous."

Investors invest with hedge funds based on their perception of the managers’ abilities, specifically the fund’s ability to achieve good performance. "Good performance, especially early in one’s career, increases a manager’s lifetime income not only through incentive fees earned at the time of the performance but also by increasing future flows of new investment to the fund, thereby increasing future fees" the paper says.

The academics posit that the extremely high level of pay for the top hedge fund managers suggests that the effect of current performance on lifetime income through future flows is likely to be important. "However, there are no estimates of its magnitude. For an incremental perc......................

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