Asset delegation, career concerns and trade volume

American Economic Review, 2012

We propose a model where investors hire fund managers to invest either in risky bonds or in riskless assets. Some managers have superior information on the default probability. Looking at the past performance, investors update beliefs on their managers and make firing decisions. This leads to career concerns which affect investment decisions, generating a positive or negative "reputational premium". For example, when the default probability is high, uninformed managers prefer to invest in riskless assets to reduce the probability of being fired. As the economic and financial conditions change, the reputational premium amplifies the reaction of prices and capital flows.

Journal of Economic Behavior & Organization, 2012

The paper proposes a model of delegated portfolio management in which career concerns lead to unprofitable trade by uninformed managers (i.e. churning). We find that churning does not necessarily reduce the return that a representative investor expects ex-ante from delegating trade to a manager. As uninformed managers churn, the level of noise in the market increases and informed managers generate higher returns than in the absence of churning. When fundamental volatility is relatively low, uninformed managers trade less aggressively and the high returns expected from informed managers more than compensate the losses expected from uninformed managers. While career concerns generally lead to an increase in trade volume, the pattern of churning that we highlight also implies that both the volume of uninformed trade and the aggregate volume of trade are positively related to the level of asset riskiness.

2009

This brief paper constructs a model of delegated portfolio management in which two agency relationships are characterized. First, a delegation process from investors to fund companies, and second, a delegation from fund companies to fund managers. Career concerns of both agents lead to a churning equilibrium in which uninformed managers trade noisily, and uninformed fund companies are willing to hire these uninformed managers. This equilibrium delivers non-fully informative prices and a positive and high trading volume. Our model then strengths previous explanations to the trade puzzle, predicting an increasing trade activity as long as institutional investors with intense delegation play an increasing role in financial markets.

2010

The traditional view on CEO pay suggests that the use of equity-based incentives (e.g., stocks and options) should increase when stock prices become more informative about managerial action. In this paper, we show this is only true in the relative sense, when comparing with CEOs' non-equity-based incentives (e.g., bonus). We confirm our model's prediction to show that the use of equity-based incentives actually falls when institutional traders impound more information in stock prices. In other words, these two mechanisms are substitutes. These predictions are crystallized by our empirical results, focusing on S&P 1,500 firms from 1992-2007. Despite the lower use of equity-based incentives and the even lower still use of bonus incentives, the CEO works harder and her total compensation increases, as suggested by our model. Our paper not only helps clarify the theoretical agency relation between CEO incentives and price efficiency due to informed trading, but also utilizes a new way to infer price informativeness from the number of institutional informed traders as well as the magnitude of their trades from a -swing‖ measure of informed trading. In its first application to the United States, we show that the swing measure can be inferred from SEC 13f filings and is robust to a number of tests.

Standard models of moral hazard predict a negative relationship between risk and incentives; however empirical studies on mutual funds present mixed results. In this paper, we propose a behavioral principal-agent model in the context of professional managers, focusing on active and passive investment strategies. Using this general framework, we evaluate how incentives affect the risk taking behavior of managers, using the standard moral hazard model as a special case. Our propositions suggest that managers of passively managed funds tend to be risk averse and tend to be rewarded without incentive fees. On the other hand, in actively managed funds, whether incentives reduce or increase the riskiness of the fund depends on how hard it is to outperform the benchmark. If the fund is likely to outperform the benchmark, incentives reduce the manager's risk appetite. Furthermore, the evaluative horizon influences the trader's risk preferences, in the sense that if traders performed poorly in a period, they tend to choose riskier investments in the following period given the same evaluative horizon. If the fund is unlikely to outperform the benchmark, the opposite is true; incentives cause increased risk taking, and if traders performed well in a given time period, they tend to choose more conservative investments following that time period.

2007

We investigate several implications of activism by institutional investors/monitors in the microstructure equilibrium postulated by . The decision whether or not to monitor, which reveals the firm's value to the fund, is stochastic. Empirically, we show that net-oftransaction-cost portfolio returns of the daily trades of active institutional fund managers are independent of their stock turnover rates. This is supportive of Noe's equilibrium in which the investor makes informed choices when she monitors and may trade "randomly" when she does not. We then identify the empirical counterpart to these "random" trades in the form of institutional "churning" trades of marginal profitability that have the effect of lowering rather than raising bid-ask spreads. These falls indicate the degree of success in camouflaging informed longer-term positions. While churning trades appear to be subject to psychological biases identified in the behavioral literature, we show that this is not the case, emphasizing their role in improving the institution's trading environment.

Management Science, 2011

We develop a framework in which we simultaneously model the interactions among investors, fund companies (represented by fund advisors), and managers. In this framework, we show that the interplay between a manager's incentives arising from her compensation structure and career concerns leads to a non-monotonic (approximately U-shaped) relation between her risk choices and prior performance relative to her peers. We empirically analyze the risk-taking behavior of a large sample of fund managers and find significant support for the predicted U-shaped relative risk-prior performance relation. Reputation concerns and employment risk plays a crucial role in driving the non-monotonic relation; significant out performers (under performers) are less (more) likely to be fired in the future, and are also more likely to increase relative risk. We also show empirical support for the additional testable implications of the theory that link determinants of the fund flow-performance relation and managerial career concerns to risk-taking behavior. Funds with higher expense ratios have less convex fund flow-performance relations and less convex U-shaped relative risk-prior performance relations.

2005

Utilizing a database of daily institutional fund manager trades, we examine the contribution of strategic trading at quarter-end associated with potential 'portfolio pumping' or 'ramping up' of reported stock prices around quarter ends. We provide the first direct evidence that active fund managers tend to purchase illiquid stocks on the last day of the quarter, in stocks in which they already hold overweight portfolio positions. Consistent with the way fund managers are evaluated, we find the poor-performing managers display greater evidence of portfolio pumping. Both increased regulatory scrutiny and improvements to market microstructure design reduce the severity of stock price changes at quarter ends.

Journal of Financial Services Research, 2004

This paper investigates how a linear contract offered to a portfolio manager affects her incentives to acquire precise information. I show that increasing the manager's portfolio share increases her demand for precise information. This result contrasts with the existing irrelevance results where the manager's portfolio share does not affect her precision choice. The irrelevance result relies on the manager facing a constant asset price, regardless of her demand. In a noisy rational expectations framework, increasing the manager's share decreases her demand and results in a less informative asset price. Thus, the manager gathers more precise information when offered a larger fraction of portfolio returns.

Financial Markets, Institutions & Instruments, 1995