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  2. ASSA Annual Meeting
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  4. Preliminary Program
  5. Hedge Funds: Incentives and Infrastructure
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Hedge Funds: Incentives and Infrastructure

Paper Session

Sunday, Jan. 3, 2021 12:15 PM - 2:15 PM (EST)

Hosted By: American Finance Association
  • Chair: Wei Jiang, Columbia University

On the Other Side of Hedge Fund Equity Trades

Xinyu Cui
,
University of Manchester
Olga Kolokolova
,
University of Manchester
George Wang
,
Lancaster University

Abstract

Hedge funds earn positive ex-post abnormal returns and avoid negative abnormal returns on their equity portfolios when trading against highly-diversied low-turnover institutional investors (quasi-indexers). This pattern is pronounced for short- and long-term holding periods, as well as if trading is conditional on return predictability associated with well-known market anomalies. It seems to be driven by the preference of quasi-indexers for liquid, high-market beta stocks, which tend to exhibit low future abnormal returns. Trading against other institutional investors or non-institutions does not result in abnormal performance for hedge funds.

Income Taxes and Managerial Incentives: Evidence from Hedge Funds

Vikas Agarwal
,
Georgia State University
Gary Chen
,
University of Illinois-Chicago
Zhen Shi
,
Georgia State University
Bin Wang
,
Marquette University

Abstract

This study examines whether increases in personal income tax rates disincentivize hedge fund
managers to exert effort. Using plausible exogenous variations in manager’s marginal personal
income tax rates, we find that higher tax rates are associated with lower fund performance.
Following a tax hike, fund managers hold stocks with lower information asymmetry, suggesting a
decline in managerial effort. We further find that higher incentives from compensation contracts help to mitigate tax-induced effort shirking. Our results highlight that higher taxes can reduce incentives of fund managers to exert effort, which can result in worse fund performance and adversely affect fund investors.

Do Prime Brokers Matter in the Search for Informed Hedge Fund Managers?

George Aragon
,
Arizona State University
Ji-Woong Chung
,
Korea University
Byoung Uk Kang
,
Hong Kong Polytechnic University

Abstract

Using the setting of funds of hedge funds (FoFs), we show that prime brokers (PBs) facilitate investors' search for informed hedge fund managers. We find that FoFs exhibit PB bias, a disproportionate preference for hedge funds serviced by their connected PBs. This PB bias is stronger when the cost of hedge fund due diligence is higher relative to capital and when the FoF's management firm generates higher prime brokerage fees. PB bias also predicts FoF performance: the highest PB-bias quartile outperforms the rest by 1.54%-2.77% per annum, after adjusting for differences in their risks.
Discussant(s)
Stefano Giglio
,
Yale University
Elisabeth Kempf
,
University of Chicago
Yuehua Tang
,
University of Florida
JEL Classifications
  • G1 - Asset Markets and Pricing