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Outsourcing Mutual Fund Management: Firm Boundaries, Incentives and Performance
Joseph Chen
University of California, Davis - Graduate School of Management
Harrison G. Hong
Princeton University - Department of Economics
Jeffrey D. Kubik
Syracuse University - Department of Economics
February 2006
Abstract:
This paper investigates the effects of managerial outsourcing on the incentives and performance of mutual funds. We first document that many families farm out the management of a sizeable fraction of their funds to unaffiliated advisory firms. We find that funds managed externally significantly under-perform those ran internally. This finding is not due to outsourced funds being managed on the cheap or by advisors of low quality as it remains even controlling for management fees and advisor fixed-effects. We then test the hypothesis that contractual externalities due to firm boundaries make it more difficult to extract performance from an outsourced relationship. We verify two key auxiliary predictions of this hypothesis: compared to counterparts ran internally, (1) an outsourced fund faces higher-powered incentives in that the likelihood that it experiences a closure or managerial termination is more sensitive to poor past performance and absolute deviation of fund risk-taking from the norm; (2) its risk-taking behavior also deviates less from the norm.
Working Paper Series
Outsourcing Mutual Fund Management Firm Boundaries, Incentives and Performance.pdf
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