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The Quality-Assuring Role of Mutual Fund Advisory Fees

Author

Listed:
  • Michel A. Habib

    (University of Zurich; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute)

  • D. Bruce Johnsen

    (George Mason University - School of Law; PERC - Property and Environment Research Center)

Abstract

Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager’s one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.

Suggested Citation

  • Michel A. Habib & D. Bruce Johnsen, 2016. "The Quality-Assuring Role of Mutual Fund Advisory Fees," Swiss Finance Institute Research Paper Series 16-16, Swiss Finance Institute, revised Apr 2016.
    • Handle: RePEc:chf:rpseri:rp1616
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    File URL: http://ssrn.com/abstract=2745907
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    Citations

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    Cited by:

    1. Laurent Barras & Patrick Gagliardini & O. Scaillet, 2018. "The Cross-Sectional Distribution of Fund Skill Measures," Swiss Finance Institute Research Paper Series 18-66, Swiss Finance Institute.
    2. Laurent Barras & Patrick Gagliardini & Olivier Scaillet, 2022. "Skill, Scale, and Value Creation in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 77(1), pages 601-638, February.

    More about this item

    Keywords

    Excessive fees; advisory fees; quality-assurance; open-access; closet indexing;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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