Fee Speech: Signalling and the Regulation of Mutual

The Investment Advisers Act of 1940 (as amended in 1970) prohibits mutual funds in the US from o ering their advisers asymmetric \incentive fee" contracts in which the advisers are rewarded for superior performance via-a-vis a chosen index but are not correspondingly penalized for underforming it. The rationale o ered in defense of the regulation by both the SEC and Congress is that incentive fee structures of this sort encourage \excessive" risk-taking by advisers. Apart from a ecting portfolio selection incentives, however, the fee structure also in uences equilibrium welfare levels in two other important ways: (a) through its risk-sharing properties, and (b) through its potential at conveying information about the adviser's abilities. This paper examines a signalling model with multiple funds and multiple risky securities in which all of these e ects are present. We nd that incentive fees do, as alleged, lead to more (and suboptimal) risktaking than do symmetric \fulcrum fees." Nonetheless, taking into account the other roles of the fee structure, we nd under robust conditions that investors may actually be strictly better o from a welfare standpoint under asymmetric incentive fee structures. In summary, we do not nd much justi cation for the regulation. Das & Sundaram: Signalling and Fee Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1