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High Water Marks

  • William N. Goetzmann


    (Yale School of Management, International Center for Finance)

  • Jonathan E. Ingersoll, Jr.


    (Yale School of Management, International Center for Finance)

  • Stephen A. Ross


    (Massachusetts Institute of Technology (MIT) - Sloan School of Management)

Incentive fees for money managers are frequently accompanied by high water mark provisions which condition the payment of the incentive upon exceeding the maximum achieved share value. In this paper, we show that these high water mark contracts are valuable to money managers, and conversely represent a claim on a significant proportion of investor wealth. We provide a closed-form solution to the high water mark contract under certain conditions. This solution shows that managers have an incentive to take risks. We conjecture that the existence of high water mark compensation is due to decreasing returns to scale in the industry. Empirical evidence on the relationship between fund return and net money flows into and out of funds suggests that successful managers, and large fund managers are less willing to take new money than small fund managers.

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Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm22.

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Date of creation: 05 Mar 2004
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Handle: RePEc:ysm:somwrk:ysm22
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  1. William N. Goetzmann & Nadav Peles, 1997. "Cognitive Dissonance And Mutual Fund Investors," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 145-158, 06.
  2. 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.
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