Trust and Delegation

Stephen Brown (), William Goetzmann, Bing Liang and Christopher Schwarz

Yale School of Management Working Papers from Yale School of Management

Abstract: Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.

Keywords: Hedge Funds; Operational Risk; Due Diligence (search for similar items in EconPapers)
JEL-codes: G2 K2 (search for similar items in EconPapers)
Date: 2009-08-17, Revised 2009-11-13
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https://repec.som.yale.edu/icfpub/publications/2545.pdf (application/pdf)

Related works:
Journal Article: Trust and delegation (2012)
Working Paper: Trust and Delegation (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:ysm:wpaper:amz2545

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