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Management Compensation and the Performance of Mutual Funds

  • Michael K. Berkowitz
  • Yehuda Kotowitz

This paper examines the mutual fund market as a market for the sale of management services using an unbalanced panel of 860 US equity funds over the 1976-1993 period. From among the performance measures for which investors have the necessary information to compute, we find that the Jensen measure best explains the change in market shares over time. It is found, however, that investors actually value the systematic component of risk more than indicated by the use of Jensen's performance measure. Our results also suggest that investors in load funds are less responsive to both components of performance (risk and return) than are investors in no-load funds. Investors, moreover, value recent past performance differently for funds with different attributes. An important result of the paper relating to the incentives provided with the widely used fixed-fee compensation schemes is that past fund performance influences individual investment decisions and hence future net asset values of funds, implying strong incentives for managers to increase their performance and by doing so, their compensation.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number berk-97-01.

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Length: 38 pages
Date of creation: 29 Apr 1997
Date of revision:
Handle: RePEc:tor:tecipa:berk-97-01
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  1. Ferson, Wayne E & Schadt, Rudi W, 1996. " Measuring Fund Strategy and Performance in Changing Economic Conditions," Journal of Finance, American Finance Association, vol. 51(2), pages 425-61, June.
  2. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  3. Jon A. Christopherson & Wayne E. Ferson & Debra A. Glassman, 1996. "Conditioning Manager Alphas on Economic Information: Another Look at the Persistence of Performance," NBER Working Papers 5830, National Bureau of Economic Research, Inc.
  4. Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
  5. Lehmann, Bruce N & Modest, David M, 1987. " Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons," Journal of Finance, American Finance Association, vol. 42(2), pages 233-65, June.
  6. 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.
  7. M. K. Berkowitz & Y. Kotowitz, 1993. "Incentives and Efficiency in the Market for Management Services: A Study of Canadian Mutual Funds," Canadian Journal of Economics, Canadian Economics Association, vol. 26(4), pages 850-66, November.
  8. Fama, Eugene F, 1972. "Components of Investment Performance," Journal of Finance, American Finance Association, vol. 27(3), pages 551-67, June.
  9. Elton, Edwin J, et al, 1993. "Efficiency with Costly Information: A Reinterpretation of Evidence from Managed Portfolios," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 1-22.
  10. Grinblatt, Mark & Titman, Sheridan, 1993. "Performance Measurement without Benchmarks: An Examination of Mutual Fund Returns," The Journal of Business, University of Chicago Press, vol. 66(1), pages 47-68, January.
  11. Brown, Stephen J, et al, 1992. "Survivorship Bias in Performance Studies," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 553-80.
  12. Bruce N. Lehmann & David M. Modest, 1985. "Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons," NBER Working Papers 1721, National Bureau of Economic Research, Inc.
  13. Goetzmann, W.N. & Ibbotson, R.G., 1990. "Do Winners Repeat? Patterns in Mutual Fund Behavior," Papers fb-_91-04, Columbia - Graduate School of Business.
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