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Fund Flows, Performance, Managerial Career Concerns, and Risk Taking

  • Ping Hu

    ()

    (Risk Analytics, Corporate Finance, Wells Fargo, Charlotte, North Carolina 28202)

  • Jayant R. Kale

    ()

    (Department of Finance, J. Mack Robinson College of Business, Georgia State University, Atlanta, Georgia 30303)

  • Marco Pagani

    ()

    (Department of Accounting and Finance, San José State University, San José, California 95192)

  • Ajay Subramanian

    ()

    (Department of Risk Management and Insurance, J. Mack Robinson College of Business, Georgia State University, Atlanta, Georgia 30303)

We develop a unified model of the interactions among investors, fund companies, and fund managers. We show that the interplay between a manager's incentives from her compensation structure and career concerns leads to a nonmonotonic (approximately U-shaped) relation between her risk choices and prior performance relative to her peers. Significantly outperforming (underperforming) managers are less (more) likely to be fired in the future and are also more likely to increase relative risk. Ceteris paribus, relative risk declines with the level of employment risk faced by a manager. Using a large sample of mutual fund managers, we find strong support for the hypothesized U-shaped relation between relative risk and prior performance. Our findings also highlight the importance of employment risk as the underlying driver of risk shifting by fund managers. Our theoretical model also generates additional hypotheses that link determinants of the fund flow-performance relation and managers' employment risk to their risk-taking behavior. In support, our empirical analysis shows that funds with higher expense ratios have less convex fund flow-performance relations and less convex U-shaped relations between relative risk and prior performance; funds with younger managers, who face greater employment risk, have more convex U-shaped relative risk-prior performance relations; and managers in larger fund families have lower incentives to engage in risk shifting, thereby leading to a less convex U-shaped relation. This paper was accepted by Wei Xiong, finance.

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File URL: http://dx.doi.org/10.1287/mnsc.1100.1305
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 57 (2011)
Issue (Month): 4 (April)
Pages: 628-646

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Handle: RePEc:inm:ormnsc:v:57:y:2011:i:4:p:628-646
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  1. Hodder, James E. & Jackwerth, Jens Carsten, 2007. "Incentive Contracts and Hedge Fund Management," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(04), pages 811-826, December.
  2. Khorana, Ajay, 2001. "Performance Changes following Top Management Turnover: Evidence from Open-End Mutual Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(03), pages 371-393, September.
  3. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Jennifer Huang & Clemens Sialm & Hanjiang Zhang, 2009. "Risk Shifting and Mutual Fund Performance," NBER Working Papers 14903, National Bureau of Economic Research, Inc.
  5. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. " Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March.
  6. Erik R. Sirri & Peter Tufano, 1998. "Costly Search and Mutual Fund Flows," Journal of Finance, American Finance Association, vol. 53(5), pages 1589-1622, October.
  7. Simon Gervais & Anthony W. Lynch & David K. Musto, 2005. "Fund Families as Delegated Monitors of Money Managers," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1139-1169.
  8. Sanjiv Ranjan Das & Rangarajan K. Sundaram, 2002. "Fee Speech: Signaling, Risk-Sharing, and the Impact of Fee Structures on Investor Welfare," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1465-1497.
  9. Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 173-208.
  10. Kempf, Alexander & Ruenzi, Stefan & Thiele, Tanja, 2009. "Employment risk, compensation incentives, and managerial risk taking: Evidence from the mutual fund industry," Journal of Financial Economics, Elsevier, vol. 92(1), pages 92-108, April.
  11. Jonathan B. Berk & Richard C. Green, 2002. "Mutual Fund Flows and Performance in Rational Markets," NBER Working Papers 9275, National Bureau of Economic Research, Inc.
  12. Kempf, Alexander & Ruenzi, Stefan, 2004. "Tournaments in mutual fund families," CFR Working Papers 04-02, University of Cologne, Centre for Financial Research (CFR).
  13. Thomas Dangl & Youchang Wu & Josef Zechner, 2008. "Market Discipline and Internal Governance in the Mutual Fund Industry," Review of Financial Studies, Society for Financial Studies, vol. 21(5), pages 2307-2343, September.
  14. William Rogers, 1994. "Regression standard errors in clustered samples," Stata Technical Bulletin, StataCorp LP, vol. 3(13).
  15. Guercio, Diane Del & Tkac, Paula A., 2002. "The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(04), pages 523-557, December.
  16. Judith Chevalier & Glenn Ellison, 1999. "Career Concerns of Mutual Fund Managers," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 389-432.
  17. Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
  18. Busse, Jeffrey A., 2001. "Another Look at Mutual Fund Tournaments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(01), pages 53-73, March.
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