Fund Flows, Performance, Managerial Career Concerns, and Risk Taking

Ping Hu (), Jayant R. Kale (), Marco Pagani () and Ajay Subramanian
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Ping Hu: Risk Analytics, Corporate Finance, Wells Fargo, Charlotte, North Carolina 28202
Jayant R. Kale: Department of Finance, J. Mack Robinson College of Business, Georgia State University, Atlanta, Georgia 30303
Marco Pagani: Department of Accounting and Finance, San José State University, San José, California 95192

Management Science, 2011, vol. 57, issue 4, 628-646

Abstract: We develop a unified model of the interactions among investors, fund companies, and fund managers. We show that the interplay between a manager's incentives from her compensation structure and career concerns leads to a nonmonotonic (approximately U-shaped) relation between her risk choices and prior performance relative to her peers. Significantly outperforming (underperforming) managers are less (more) likely to be fired in the future and are also more likely to increase relative risk. Ceteris paribus, relative risk declines with the level of employment risk faced by a manager. Using a large sample of mutual fund managers, we find strong support for the hypothesized U-shaped relation between relative risk and prior performance. Our findings also highlight the importance of employment risk as the underlying driver of risk shifting by fund managers. Our theoretical model also generates additional hypotheses that link determinants of the fund flow-performance relation and managers' employment risk to their risk-taking behavior. In support, our empirical analysis shows that funds with higher expense ratios have less convex fund flow-performance relations and less convex U-shaped relations between relative risk and prior performance; funds with younger managers, who face greater employment risk, have more convex U-shaped relative risk-prior performance relations; and managers in larger fund families have lower incentives to engage in risk shifting, thereby leading to a less convex U-shaped relation. This paper was accepted by Wei Xiong, finance.

Keywords: mutual funds; asset flows; relative risk; ability; career concerns; employment risk (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (37)

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