Skin in the Game versus Skimming the Game: Governance, Share Restrictions and Insider Flows
Hedge-fund managers justify share restrictions as means of protecting the common interest of the shareholders. However, this paper advances that such restrictions can adversely induce information asymmetry between managers and their clients about future fund flows.
The paper demonstrates that share-restricted funds with recent outflows underperform funds with recent inflows by about 5.6% annually over 1998—2008. No such return spread is observed for funds with low-share restrictions. As managers may also act as investors in their own funds, the information asymmetry potentially allows them to profit by trading in advance of their clients. Consistent with this hypothesis, funds exhibit significant capital outflows following a decrease in managerial allocation. The flow return spread is also more pronounced in funds managing insider wealth, as well as in funds with low levels of corporate governance. Moreover, the flow of low-fee funds leads that of high-fee funds within the same hedge-fund family, suggesting that fund insiders enter or exit the fund prior to outside investors. The results suggest that private information about the fund, not only about the fundamental value of its assets, may constitute material information. Such private information engenders potential conflict of interest between fund managers and investors, with implications for proper fund governance as well as appropriate disclosure policy concerning managerial actions.
Skin in the Game versus Skimming the Game: Governance, Share Restrictions and In...
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