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Fee Speech: Signaling, Risk-Sharing, and the Impact of Fee Structures on Investor Welfare

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  • Sanjiv Ranjan Das
  • Rangarajan K. Sundaram

Abstract

The fee structure used to compensate investment advisers is central to the study of fund design, and affects investor welfare in at least three ways: (i) by influencing the portfolio-selection incentives of the adviser, (ii) by affecting risk-sharing between adviser and investor, and (iii) through its use as a signal of quality by superior investment advisers. In this paper, we describe a model in which all of these features are present, and use it to compare two popular and contrasting forms of fee contracts, the "fulcrum " and the "incentive " types, from the standpoint of investor welfare. While the former has some undeniably attractive features (that have, in particular, been used by regulators to justify its mandatory use in a mutual fund context), we find surprisingly that it is the latter that is often more attractive from the standpoint of investor welfare. Our model is a flexible one; our conclusions are shown to be robust to many extensions of interest. The results are also extended to consider unrestricted fee structures and competitive markets for fund managers. Copyright 2002, Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 15 (2002)
Issue (Month): 5 ()
Pages: 1465-1497

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Handle: RePEc:oup:rfinst:v:15:y:2002:i:5:p:1465-1497

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Cited by:
  1. Agarwal, Vikas & Gómez, Juan-Pedro & Priestley, Richard, 2012. "Management compensation and market timing under portfolio constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 36(10), pages 1600-1625.
  2. Sandeep Kapur & Allan Timmermann, 2004. "Relative Performance Evaluation Contracts and Asset Market Equilibrium," Finance 0408001, EconWPA.
  3. repec:pdn:wpaper:76 is not listed on IDEAS
  4. Gil Bazo, Javier & Martínez Sedano, Miguel Angel, 2003. "The Black Box of Mutual Fund Fees," DFAEII Working Papers 2004-01, University of the Basque Country - Department of Foundations of Economic Analysis II.
  5. Salvatore Piccolo & Giovanni W. Puopolo & Luis Vasconcelos, 2013. "Non-Exclusive Financial Advice," CSEF Working Papers 347, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  6. Natasa Bilkic & Thomas Gries, 2014. "Destructive Agents, Finance Firms, and Systemic Risk," Working Papers CIE 76, University of Paderborn, CIE Center for International Economics.
  7. Sheng, Jiliang & Wang, Jian & Wang, Xiaoting & Yang, Jun, 2014. "Asymmetric contracts, cash flows and risk taking of mutual funds," Economic Modelling, Elsevier, vol. 38(C), pages 435-442.

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