Role of managerial incentives and discretion in hedge fund performance VIKAS AGARWAL , NAVEEN

Using a comprehensive hedge fund database, we examine the role of managerial incentives and discretion in hedge fund performance. Hedge funds with greater managerial incentives, proxied by the delta of the option-like incentive fee contracts, higher levels of managerial ownership, and the inclusion of high-water mark provisions in the incentive contracts, are associated with superior performance. The incentive fee percentage rate by itself does not explain performance. We also find that funds with a higher degree of managerial discretion, proxied by longer lockup, notice, and redemption periods, deliver superior performance. These results are robust to using alternative performance measures and controlling for different data-related biases. __________________________________________ Agarwal is from Georgia State University and works with the Center for Financial Research, University of Cologne; Daniel is from Drexel University; and Naik is from London Business School. We thank an anonymous referee for insightful comments and suggestions that substantially improved the paper, and Robert F. Stambaugh (the editor) for valuable guidance and insights. We would also like to thank Bruno Biais, Nicole Boyson, Conrad Ciccotello, Jeff Coles, Ben Esty, Patrick Fauchier, Miguel Ferreira, William Fung, Gerald Gay, Mila Getmansky, David Goldreich, Paul Gompers, William Goetzmann, Jason Greene, Roy Henriksson, David Hsieh, Drago Indjic, Alexander Ineichen, Jayant Kale, Ron Kaniel, Alexander Kempf, Omesh Kini, Robert Kosowski, Klaus Kreuzberg, Pete Kyle, Paul Laux, Lalitha Naveen, Sebastien Pouget, Tarun Ramadorai, Krishna Ramaswamy, David Ravenscraft, Stefan Ruenzi, Chip Ryan, David Stolin, Ajay Subramanian, Isabel Tkatch, Dimitri Vayanos, David Webb, Ivo Welch, and participants at the Autumn seminar of INQUIRE Europe, All-Georgia conference, Duke University, FDIC/JFSR conference on Risk Transfer and Governance in the Financial System, FEP Universidade do Porto, Georgia State University, Gutmann Symposium on hedge funds, INQUIRE UK, ISCTE Lisbon, London Business School, London School of Economics, Singapore Management University, Third Annual Conference on Corporate Finance at Washington University St. Louis, University of Cologne, University of North Carolina, and Wharton Hedge Fund conference for many helpful comments and constructive suggestions on an earlier version of this paper. Vikas is grateful for the research support in form of a research grant from the Robinson College of Business of Georgia State University. We are grateful for funding from INQUIRE Europe and support from BNP Paribas Hedge Fund Centre at London Business School. We are grateful to Center for International Securities and Derivatives Markets, Hedge Fund Research Inc., TASS Investment Research Ltd., and MSCI for providing us with the data on hedge funds. We are thankful to Burak Ciceksever, Otgontsetseg Erhemjamts, and Purnendu Nath for excellent research assistance. We are responsible for all errors.