Skin in the Game versus Skimming the Game: Governance, Share Restrictions, and Insider Flows

Abstract

This paper advances the proposition that share restrictions engender potential conflicts of interest between fund managers and investors. Fund flows predict future fund returns for share-restricted funds, especially among funds with low levels of governance and funds managing insiders’ wealth, providing managers incentive to trade in advance of their clients. Some direct evidence for such managerial action is presented, using proprietary data on managerial investment in their own funds. The evidence suggests that private information about a fund, not necessarily its holdings, may constitute material information, with implications for proper fund governance and disclosure policy concerning managerial actions.

Hedge fund leverage: 2002–2017

“…The average time since the last audit date is about 35 months. The fund governance measure GOV (see Ozik & Sadka, ) has an average of 1.34 out of 4. The average assets under management (AUM) of all the fund/month observations is about $775 million.…”

“…On the other hand, a fund with strong fund governance is more likely to have better access to credit. Inspired by the corporate‐governance literature (Gompers, Ishii, & Metrick, ; La Porta, Lopez‐de‐Silanes, Shleifer, & Vishny, ; Ozik & Sadka, ), we consider several fund characteristics to act as a proxy for fund governance: whether the fund had been audited in the past 12 months, whether it has a high‐water mark, whether it is an onshore domiciliation, and whether registration with the Securities and Exchange Commission (SEC) exists. Following Ozik and Sadka (), we aggregate these variables to devise an aggregate measure of fund governance.…”

Hedge Fund Boards and the Market for Independent Directors

“…As the first, large-scale study to examine hedge fund boards and the market for their directors, we contribute to the growing literature that examines the governance mechanisms hedge funds use to manage agency conflicts (e.g., Brown, Goetzmann, Liang, and Schwarz (2008), (2012), Agarwal, Daniel, and Naik (2009), Cumming and Dai (2010), Dimmock and Gerken (2012), Cumming, Dai, and Johan (2013), Ozik and Sadka (2015), and Aiken et al (2015)). For instance, some studies find a positive association between fund misconduct and the quality of internal controls such as signature processes governing cash transfers, pricing and disclosure practices, and the quality of service providers such as auditors or administrators (Cassar and Gerakos (2010), Brown et al (2012)).…”

“…Some examples include: Schwarz (2008, 2012),Agarwal, Daniel, and Naik (2009),Cumming and Dai (2010),Dimmock and Gerken (2012),Cumming, Dai, and Johan (2013),Ozik and Sadka (2014),and Aiken, Clifford, and Ellis (2015) …”

Hedge fund incentives, management commitment and survivorship

“…Later he became an adviser to a different hedge fund, Peak Ridge Capital. 5 Ozik and Sadka (2015) show that fund managers with skin in the game tend to profit from inside information about fund flows and they have the incentive to withdraw personal capital stakes precede investors. In these circumstances, if hedge fund managers purposely self-select to participate and unobserved factors are not controlled simply by treating personal capital as an exogenous covariate as in prior literature, the effect of personal capital on survival risk cannot be interpreted.…”