Fund Managers, Career Concerns, and Asset Price Volatility

Effective monitoring by equity blockholders is important for good corporate governance. A prominent theoretical literature argues that the threat of block sale ("exit") can be an effective governance mechanism. Many blockholders are money managers.We show that when money managers compete for investor capital, the threat of exit loses credibility, weakening its governance role. Money managers with more skin in the game will govern more successfully using exit. Allowing funds to engage in activist measures ("voice") does not alter our qualitative results. Our results link widely prevalent incentives in the ever-expanding money management industry to the nature of corporate governance.Equity blockholders in publicly traded corporations who are dissatisfied with the actions of company management can sell their blocks-the so-called "Wall Street Walk." A growing * Dasgupta is at the London School of Economics, and is affiliated with CEPR and ECGI. 1 Accepted ArticleThis article is protected by copyright. All rights reserved. This article has been accepted for publication and undergone full peer review but has not been through the copyediting, typesetting, pagination and proofreading process, which may lead to differences between this version and the Version of Record. Please cite this article as doi: 10.1111/jofi.12308. theoretical literature starting with Pfleiderer (2009) andEdmans (2009) argues that the Wall Street Walk can be an effective form of governance. The exit of a blockholder will typically depress the stock price, punishing management whenever executive compensation is linked to the market price of equity. Thus, faced with a credible threat of exit, management will be reluctant to underperform. Admati and Pfleiderer argue that when blockholders observe managers underperforming, it is in their own interest to exit early before information about the manager's underperformance becomes public. This makes exit a credible threat that ameliorates managerial underperformance and enhances firm value. Edmans argues that informed institutional trading enhances the informational efficiency of the firm's equity in the secondary market, enabling myopic managers to make better investment decisions.The theoretical literature on exit treats the blockholder as a profit-maximizing principal:she acts as an individual owner of an equity block would. In contrast, a significant proportion of equity blocks is held by delegated portfolio managers who manage money for others (for example, mutual funds, and hedge funds).1 This matters because money managers often face short-term incentives that may lead them to behave in ways that are not conducive to good corporate governance. For example, as the EU (2011) Corporate Governance GreenPaper notes, It appears that the way asset managers' performance is evaluated... encourages asset managers to seek short-term benefits... The Commission believes that shortterm incentives... may contribute significantly to asset managers' short-termism, which probably has an impact on shareh...

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confidence: 86%

The Wall Street Walk when Blockholders Compete for Flows

Dasgupta¹,

Piacentino

2015

“…Investment incentives at the insurance firms—discussed in more detail in the next section—are largely consistent with the framework outlined by Rajan (); in particular, in the absence of default, performance is evaluated based on promised yields. As in Gurrieri and Kondor (), Rajan () is not specific about which yield spread components are being mismeasured, but inability to properly assess risk by the ultimate investor is central to both frameworks, and both frameworks accommodate the type of risk mismeasurement that we see for insurance firms…”

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confidence: 99%

“…First, downgrade probabilities rise during economic recessions, so the ratings of some high‐risk bonds may be less stable. Reaching for yield could also be curtailed because of increased scrutiny of investment managers by owners or regulators (Gennaioli, Shleifer, and Vishny ()), or because lower quality managers become unwilling to take risks they do not understand (Gurrieri and Kondor ()). A shift in the riskiness of the environment or a shift in interest rate regime can make reaching for yield less attractive.…”

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confidence: 99%

“…Iannotta and Pennacchi () show that, when capital requirements reflect default risk but not covariances, in other words, capture

PD \times LGD

but not RP , banks can increase shareholder value by investing in assets with relatively high systematic risk. In Gurrieri and Kondor () behavior akin to reaching for yield arises as a result of unobservable heterogeneity in investment skill and career concerns for portfolio managers. A nice feature of the model is that it generates time‐varying reaching behavior.…”

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confidence: 99%

See 1 more Smart Citation

Reaching for Yield in the Bond Market

Becker¹,

Ivashina

2015

449

112

Reaching-for-yield-investors' propensity to buy riskier assets in order to achieve higher yields-is believed to be an important factor contributing to the credit cycle. This paper presents a detailed study of this phenomenon in the corporate bond market. We show that insurance companies, the largest institutional holders of corporate bonds, reach for yield in choosing their investments. Consistent with lower rated bonds bearing higher capital requirement, insurance firms' prefer to hold higher rated bonds. However, conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. Reaching-for-yield exists both in the primary and the secondary market, and is robust to a series of bond and issuer controls, including bond liquidity and duration, and issuer fixed effects. This behavior is related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding. A comparison of the ex-post performance of bonds acquired by insurance companies shows no outperformance, but higher systematic risk and volatility.

“…Our study of incentives in money management follows, but takes a different approach from, traditional work on performance incentives (e.g., Chevalier and Ellison (, )). Two recent papers that address some of the issues we focus on here, but in the traditional context in which reputations are shaped entirely by performance, are Guerrieri and Kondor () and Kaniel and Kondor (). Closer to our work are the papers by Inderst and Ottaviani (, , ), who focus on distorted incentives to sell financial products arising both from the difficulties of incentivizing salesmen to sell appropriate products and from actual kickbacks.…”

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confidence: 99%

Money Doctors

Gennaioli¹,

Shleifer²,

Vishny

2015

454

258

We present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor's perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average underperform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs.* The authors are from Universita Bocconi and IGIER, Harvard University, and University of Chicago, respectively. We are grateful to Charles Angelucci, Nicholas Barberis, John Campbell, Roman Inderst, Sendhil Mullainathan, Lubos Pastor, Raghuram Rajan, Jonathan Reuter, Joshua Schwartzstein, Charles-Henri Weymuller, Luigi Zingales, Yanos Zylberberg, and especially a referee for extremely helpful comments. Disclosure: Shleifer was a co-founder of LSV Asset Management, a money management firm, but is no longer a shareholder in the firm. Shleifer's wife is a partner in a hedge fund, Bracebridge Capital. Vishny was a co-founder of LSV Asset Management. He retains an ownership interest.