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RFS Advance Access originally published online on March 29, 2008
Review of Financial Studies 2009 22(5):1777-1815; doi:10.1093/rfs/hhn023
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org

Incentives and Mutual Fund Performance: Higher Performance or Just Higher Risk Taking?

Massimo Massa and Rajdeep Patgiri
INSEAD

Address correspondence to Massimo Massa, INSEAD, Finance Department, Boulevard de Constance, 77300 Fontainebleau, France; telephone: +33-1-6072-4481; fax: +33-1-6072-4045; or e-mail: massimo.massa{at}insead.edu.

JEL Classification: G23, G30, G32


  Abstract

We study the impact of contractual incentives on the performance of mutual funds. We find that high-incentive contracts induce managers to take more risk and reduce the funds’ probability of survival. Yet, funds with high-incentive contracts deliver higher risk-adjusted return, and the superior performance remains persistent. The top incentive quintile of funds outperforms the bottom quintile by 2.70% per year. Moreover, high-incentive winner funds from one year have a positive alpha of 0.41% per month in the following year. Focusing on funds’ holdings, we show that active portfolio rebalancing is the main channel through which incentives increase performance.

We thank Matthew Spiegel and an anonymous referee for comments that substantially improved the paper, and William Fisk and Sriram Ganesan of INSEAD Financial Data Center for their invaluable help with the name-recognition algorithm. All remaining errors are our own.


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