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Abstract
This thesis studies the effects of incentives, contracts, liquidity management, and information on the asset management industry. First, the welfare of financial professionals frequently depends both on tournament rewards for relative performance (e.g., fund inflows based on fund ranking), and high-powered bonus for absolute performance (e.g., hedge-fund performance fees). It is well known that both high-powered compensation and tournament rewards engender risk taking. Understanding how the two types of rewards interact with each other and affect managers’ risk-taking strategies is of great importance and the main goal of this study. Surprisingly, we show that these two sources of risk taking, tournaments and bonus compensation, mollify the risk-taking incentives produced by the other source. Second, in global financial markets, open-end mutual funds manage a significant amount of assets. However, a key structural vulnerability of their asset management activities is the potential mismatch in investment liquidity and daily redeemability, which, during market stress periods, will lead to runs on funds. In this study, we draw attention to a new market development, alternative pricing rules, aiming to adjust funds’ net asset values to pass on funds’ trading costs to transacting shareholders. Using unique data on investor transactions, we find that the new rules eliminate the first-mover advantage and help funds retain investor capital during stressed market conditions. Finally, the third study reconciles some stylized facts of asset markets: a remarkable growth in the money invested with index funds, a drop of fund delegation fees, active managers opting to be “closet indexers,” and increased investor heterogeneity. Through theoretically modeling the rational asset allocation strategies of investors, I show that wealth inequality increases demand for indexing: active funds attract the wealthiest households, who are more willing to detect closet indexing. Active fund managers have to compete more aggressively through information acquisition, which lowers their excess returns and thus delegation fees.
