The Servant of Two Masters: A Common Agency Explanation for Side-by-Side Management

Abstract

Side-by-side (SBS) management refers to the practice that a fund manager/family simultaneously manages two funds and separately contracts with the two fund principals. In this paper, I present a common agency model to study the motivations for and effects of SBS. With decentralized contracting, there are two types of contractual externalities: the manager’s efforts are substitute and the effort exerted on one fund generates a performance spillover on the rival fund. When one principal increases incentives, the rival principal has two choices to respond: she can either compete by increasing incentives or free ride by reducing incentives but enjoy the spillover effect. Under public contracting, competition is more likely to dominate free-riding. Under private contracting, however, free-riding becomes important. In either contracting, SBS could generate better performance relative to standalone management. As a result, this paper reconciles the conflicting findings on SBS management in Cici, Gibson and Moussawi (2010) and Nohel, Wang and Zheng (2010). The proposed model also provides new testable implications such that SBS is more likely to happen in fund families and to be managed by managers with higher ability. JEL Classification: G10, G20, G30, G23, G32