Risking or De-Risking: How Management Fees Affect Hedge Fund Risk-Taking Choices
88 Pages Posted: 17 Jan 2017 Last revised: 29 Oct 2020
Date Written: June 12, 2020
Hedge fund managers’ risk-taking choices are determined by their compensation structure. Most existing studies focus on how the incentive fee and the high-water mark provision affect managers’ risk-taking. We build a simple model to show that managers’ risk-taking is negatively related to their future management fees. Using fund-level data, we calibrate the present value of managers’ future compensation and find that the management fee is the dominant part of managers’ total compensation. When the contribution of future management fees to total compensation increases, fund managers, especially those of large funds, reduce risk-taking to increase survival probabilities and protect future compensation.
Keywords: Hedge Fund, Risk-Taking, Incentive Fee, Management Fee, High-Water Mark
JEL Classification: G20, G23, G29
Suggested Citation: Suggested Citation