The quality-assuring role of mutual fund advisory fees

Michel Habib and D. Bruce Johnsen

No 10438, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager's one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.

Keywords: Excessive fees; Advisory fees; Quality-assurance; Open-access; Closet indexing (search for similar items in EconPapers)
JEL-codes: D23 D86 G23 L22 (search for similar items in EconPapers)
Date: 2015-02
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