Advisory Fees Research Articles

The Quality-Assuring Role of Mutual Fund Advisory Fees

Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager's one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.

Industry Expertise, Information Leakage and the Choice of M&A Advisors

AbstractThis paper examines the impacts of M&A advisors’ industry expertise on firms’ choice of advisors in mergers and acquisitions. We show that an investment bank's expertise in merger parties’ industries increases its likelihood of being chosen as an advisor, especially when the acquisition is more complex, and when a firm in M&A has less information about the merger counterparty. However, due to the concerns about information leakage to industry rivals through M&A advisors, acquirers are reluctant to share advisors with rival firms in the same industry, and they are more likely to switch to new advisors if their former advisors have advisory relationship with their industry rivals. In addition, we document that advisors with more industry expertise earn higher advisory fees and increase the likelihood of deal completion.

The quality-assuring role of mutual fund advisory fees

Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager's one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.

BAY 81-8973, a Full-Length Recombinant Factor VIII: Results from Assay Field Study

▪Background: BAY 81-8973 is a full-length unmodified recombinant factor VIII (rFVIII) in development for the treatment of hemophilia A. BAY 81-8973 has the same amino acid sequence as Bayer's sucrose-formulated rFVIII but is manufactured using the latest technologies. Potency labeling is based on the chromogenic assay. BAY 81-8973 has demonstrated an excellent safety and efficacy profile in the clinical development program. This field study was conducted to evaluate assay variability in BAY 81-8973 measurements compared with a marketed rFVIII (Advate®, Baxter, Westlake Village, CA) using the methods, reference standards, and reagents typically used in clinical laboratories.Methods: Clinical laboratories in North America, Europe, Israel, and South Africa were invited to participate in the study. Each laboratory was provided with 21 blinded samples to analyze using their routine assay (one-stage, chromogenic, or both), reagents, and standards. The 21 samples consisted of 3 aliquots each of spiked hemophilia plasma containing normal von Willebrand factor levels with BAY 81-8973 at 3 different levels: <10 IU/dL (low), 10-50 IU/dL (medium), >50 IU/dL (high); 3 aliquots each of spiked hemophilia plasma with Advate at the same levels (low, medium, high); and 3 aliquots of commercially available positive control sample (normal human plasma). Samples were identified by unique numbers and by target FVIII levels (low, medium, high). The nominal spiked target levels of FVIII concentration were 0.043 IU/mL (low), 0.375 IU/mL (medium), and 0.865 IU/mL (high) for BAY 81-8973 and Advate and 0.960 IU/mL for the plasma control. Results were analyzed statistically for intra- and interlaboratory variability.Results: Of 82 laboratories contacted, 41 in 11 countries participated. Thirty-one laboratories used the one-stage assay only, 1 used the chromogenic assay only, and 9 used both assays. Intralaboratory variability was <11% for both assays at all FVIII levels and was similar for BAY 81-8973, Advate, and the plasma control. Interlaboratory variability was highest for the lowest concentration using the chromogenic assay (percent coefficient of variation: 60% for BAY 81-8973, 51% for Advate) and decreased to 14% for BAY 81-8973 (Advate, 12%; plasma control, 10%) with the one-stage assay and 5% (Advate, 6%; plasma control, 7%) with the chromogenic assay at the highest concentration. For the 9 laboratories that used both the one-stage and chromogenic assays, the chromogenic:one-stage ratio for mean values for BAY 81-8973 at low, medium, and high concentrations was 1.04, 1.04, and 1.14, respectively; for Advate, the ratios were 1.02, 1.07, and 1.21.Conclusions: The laboratories participating in this field study used a wide range of methods and reagents for FVIII measurements. The variability of the results was similar for both BAY 81-8973 and Advate and highest for low concentrations. There was no relevant difference in the results between the one-stage and chromogenic assays. DisclosuresMaas Enriquez:Bayer Pharma AG: Employment. Beckmann:Bayer Pharma AG: Employment. Katterle:Bayer Pharma AG: Employment. Bruns:Winicker Norimed: Employment. Tseneklidou-Stoeter:Bayer Pharma AG: Employment. Kitchen:Bayer Pharma AG: Other: Advisory fees, Speakers Bureau.

Too Big to Tax? Vanguard and the Armms Length Standard

Vanguard is the world’s largest complex of mutual funds, with over $3 trillion in assets under management, including $215 billion added in 2014. Vanguard’s main attraction to investors is its low costs. Profs. Freeman and Brown (2000) report that the advisory fees charged by the Vanguard Group “tend to present lower expense ratios than the rest of the mutual fund industry” because “Vanguard funds are run on the same basis as most companies in the economy: boards are unswervingly devoted to making as much money as possible…for shareholders [of the funds]. Stated differently, Vanguard funds are uncontaminated by the conflict of interest that affects most of the rest of the fund industry.” Michael Rawson, a Morningstar analyst, told the Financial Times in May 2015 that “[i]t is phenomenal that a single company could represent almost 20 percent of the US mutual fund industry. But they have done it through offering products that are consistently lower cost than other funds”. The main reason for Vanguard’s lower fees than, for example, the fees charged by Fidelity (its closest rival) is that Vanguard has a unique structure, approved by the SEC in 1975: The investment manager (Vanguard Group Inc., or VGI) is owned by the Vanguard domestic mutual funds (the Funds) in proportion to Net Asset Value. This structure, Profs. Freeman and Brown argue, means that there is no conflict of interest between VGI and the Funds, while every other mutual fund complex has the advisor charging too much because it puts the interest of shareholders of the advisor ahead of investors that are shareholders of the funds.Coates and Hubbard (2007) have argued that this situation should result in investors moving from other funds to Vanguard, and the recent phenomenal growth of Vanguard suggests that they were right. But there is a problem: As David Danon, a former Vanguard in-house tax lawyer, has argued in a lawsuit filed in 2013, the Vanguard structure directly contravenes the arm’s length standard of Treags. Reg. 1.482-1(b)(1) because VGI provides services to the Funds “at cost”, i.e., without charging an arm’s length profit. VGI is a C corporation and the Funds are Regulated Investment Companies (RICs) not taxable at the corporate level, so this situation results in avoidance of billions of corporate taxes. The IRS has not taken action on Danon’s whistleblower complaint, nor has the NY Attorney General intervened in his qui tam lawsuit against Vanguard. Given the millions of Americans that have invested in Vanguard funds and the billions in tax at stake (which would presumably be borne by the investors in the Funds if Vanguard raises its fees to include the tax), this case raises the question: Is Vanguard too big to tax?This article will argue (a) that the Vanguard “at cost” pricing is unsustainable under the arm’s length standard, and that the IRS will win in court if it challenges Vanguard’s transfer pricing; (b) that the Vanguard case illustrates some of the problems with the arm’s length standard and would have been avoided had unitary taxation principles been applied to Vanguard and its Funds.

Information Production and Conflicts of Interest in Financial Intermediation: The Effects of Stapled Finance

We examine whether financing commitments from a target firm's financial advisor, in the form of stapled financing, provide certification of target value. Using a dataset of leveraged buyouts spanning 2002-2011, and addressing endogeneity issues, we find that stapled financing has significantly positive effects on sellers' shareholder wealth, especially for targets suffering from greater adverse selection. Stapled financing facilitates deal financing by allowing buyers to obtain lower cost and longer maturity debt, and is positively associated with bidding intensity. Investment banks offering stapled financing appear to trade off higher expected advisory fees against loss of lending efficiency ex-post.

Gartenberg: Some Empirical Clarity

The issue of mutual fund advisory fees has a long and contentious history. Reports by the Wharton School and the SEC in the 1960’s found that mutual fund sponsors overcharged their captive mutual funds relative to institutional clients. This led to the 1970 Amendment to the Investment Company Act which made fund sponsors fiduciaries with respect to advisory fees. The Gartenberg case established the fiduciary standard to gauge advisory fees. Freeman and Brown updated the Wharton and SEC reports and found that fund sponsors continue to overcharge mutual fund clients. This led to push back from the fund sponsor industry which sponsored research purporting to demonstrate that mutual fund markets are highly competitive and thus fund sponsors could not charge excess fees or they would be driven from the business by low fee competitors. Economic theory is clear that firms operating in competitive industries earn normal profits and normal rates of return for their owners while firms that have monopoly pricing power are able to earn economic profits and earn excess returns for their owners. This paper examines these issues in a fund sponsor context and finds that the universe of publicly traded mutual funds sponsors is extraordinarily profitable and the shareholders in mutual fund sponsoring firms earn excess rates of return over very long time periods.

Mutual Funds’ Soft Dollar Arrangements: Determinants, Impact on Shareholder Wealth, and Relation to Governance

Mutual fund advisers either expense the cost of research and other services or pay for them with soft dollars. This study is the first to use actual soft dollar and total brokerage commission figures for a large number of funds and to examine how soft dollars are linked to mutual fund governance. Employing a survivorship bias-free sample of actively managed US mutual funds, we find that higher soft dollar and total brokerage commissions are associated with higher advisory fees but not with higher risk-adjusted fund returns. These findings suggest that mutual fund shareholders, on average, do not benefit from the research and the information supplied by third parties such as brokers. We also find that larger and more highly compensated boards are associated with lower advisory fees. Larger boards are also associated with slightly lower turnover. The median tenure of board directors is negatively correlated with soft dollar commissions and turnover, but not correlated with total brokerage commissions or the cost of turning over a portfolio. Higher proportions of directors with a finance background are associated with higher advisory fees, brokerage commissions, and turnover costs. These associations might indicate greater agency costs.

Are Mutual Fund Investors Paying for Noise?

We demonstrate that advisory fees exhibit a positive concave dependence on the idiosyncratic volatilities of mutual fund returns. Our theoretical analysis attributes this to the impact of idiosyncratic noise on performance opacity, coupled with the infeasibility of short-selling mutual fund shares. Echoing the literature on the principal-agent model for executive compensation, we show that previous estimates of the fee-performance sensitivity for mutual funds are negatively biased, since they do not account for the impact of idiosyncratic noise on fees and performance. Finally, we show that investor sophistication reduces the dependence of advisory compensation on idiosyncratic noise.

Mutual Fund 'Soft-Dollar' Arrangements: Performance and Related Analysis

In brief, mutual fund bundling services under soft-dollar arrangements may benefit shareholders. However, it is also possible shareholder capital is wasted through these arrangements. There are two major questions concerning bundling actively managed equity fund research and services in soft-dollar arrangements. First, do these arrangements provide higher risk-adjusted fund performance and/or lower advisory fees? Or, second, are shareholder assets wasted through use of soft-dollar arrangements? The research findings say “yes” only to the second question.

The spiritual heart: Can gratitude change cardiac biology?

Perhaps the poets were correct after all. Their correlation of emotional status with our hearts—cold, broken, and so forth—is now being supported by high-quality correlational analysis and even some controlled studies. This represents a huge opportunity for preventing cardiovascular diseases (CVD), the leading cause of death and disability worldwide. Heart failure (HF) is a particular deadly form of CVD (Bui, Horwich, & Fonarow, 2011) where despite much progress in preventive strategies (e.g., medications, exercise, diet), prognosis remains poor and 5-year mortality rates are still about 50% (Bui et al., 2011). The magnificent 13th century poet Rumi also noted that we should “ignore those that make you fearful and sad, that degrade you back toward disease and death.” But only over the past 50 years or so has modern medicine accepted that negative psychological attributes, such as hostility, stress, or depression, may be linked to adverse CVD outcomes (Steptoe & Molloy, 2007). However, medical interventions for negative affective traits, such as antidepressant pills, have not consistently improved cardiac outcomes (Thombs et al., 2013). For example, in the 12-week SADHART-CHF (Sertraline Against Depression and Heart Disease in Chronic Heart Failure) trial of 469 patients (LVEF 45%), antidepressant therapy did not produce significant improvements in either depression or HF status (O’Connor et al., 2010). In this issue of the journal, Mills et al. (2015) report on a highly intriguing association between spirituality, gratitude, and HF selfefficacy profiles. In a study of 186 subjects, higher levels of self-reported gratitude were correlated with better sleep, reduced depression and fatigue, reduced inflammatory markers, and higher levels of self-efficacy to maintain heart function. Further, a path analysis found that gratitude fully or partially mediated the links between self-reported spiritual well-being and psychological well-being (sleep and mood). The findings point to the need for behavioral cardiology to move beyond just a focus on negative psychology. A core tenet of the field of positive psychology (Layous, Chancellor, Lyubomirsky, Wang, & Doraiswamy, 2011) is that we can learn more about humans by studying what’s right (e.g., gratitude, happiness) in flourishing individuals than by studying what’s wrong (e.g., depression). Research over several decades has elucidated not only why some people are more likely P. Murali Doraiswamy, Department of Psychiatry, Duke Medicine and the Duke Institute for Brain Sciences; Mehmet C. Oz, Department of Surgery, New York-Presbyterian Hospital and Columbia University. P. Murali Doraiswamy has received research grants and advisory fees from several health companies for other studies/talks. He also owns stock in companies whose products are not discussed here. He is a collaborative investigator in the SBTI study. Mehmet C. Oz is the host of The Dr. Oz Show. Correspondence concerning this article should be addressed to P. Murali Doraiswamy, DUMC-3018, Duke University Medical Center, Durham, NC 27710. E-mail: murali .doraiswamy@duke.edu T hi s do cu m en t is co py ri gh te d by th e A m er ic an Ps yc ho lo gi ca l A ss oc ia tio n or on e of its al lie d pu bl is he rs .

Moral Hazard in Mutual Fund Management: The Quality-Assuring Role of Fees

Active fund managers implicitly promise to research profitable portfolio selection. But active management is an experience good subject to moral hazard. Investors cannot tell high from low quality up front and therefore fear manager shirking. We show how the parties mitigate the moral hazard by paying the manager a premium fee sufficiently high that the manager’s one-time gain from shirking is less than the capitalized value of the premium stream he earns from maintaining his promise to provide high quality. Premium advisory fees act as a quality-assuring bond. Our model has a number of revealing extensions and comparative statics.

Axis–Enam: The Investment Banking Marriage—Will They Produce Superior Cash Flows?

The India-based private-sector financial institution Axis Bank demonstrated its triumph moving into the investment-banking business by acquiring the privately owned Enam Securities. Indeed, Axis considered that the Enam deal would generate superior cash flows in the growing competitive prolific business, that is, financial advisory services. In other words, the merger with Enam was only a forward integration, which might help in collecting a fee-based income and advisory fee that strengthens future earnings. Axis shareholders were poignant when the corporate board declared a merger announcement with Enam. In this regard, had they been influenced by new market information, which was formally a merger announcement? Likewise, did Axis shareholders benefit from this merger? Will Axis sustain their acquired business in the growing advisory services? How did Axis benefit from the non-compete agreement with Enam? More importantly, will they produce superior future free cash flows? In addition, students would learn various motives behind bank mergers in India and business opportunities in investment banking. Specifically, students would acquire hands-on experience related to the estimation of future free cash flows and business valuation. List of supplementary materials: Teaching note, exercises with solutions (spreadsheets are available upon request).

Social Ties in the Making of an M&amp;A Deal

This paper investigates whether and how social ties between targets and acquirers affect merger outcomes. I use merger-related SEC filings and news articles to detect if a social tie between directors or executives of merging firms is effective during the making of the deal. When there is a social tie, abnormal announcement returns accruing to the combined entity and to the acquirer firm are reduced by 2.4 and 2.8 percentage points, respectively. This adverse effect is mainly driven by deals in which the social tie is distant. Irrespective of the closeness of the tie, acquirer-target social ties significantly decrease the likelihood of receiving competing bids in the private takeover process. Moreover, connected deals, particularly those involving close ties, are associated with lower financial advisory fees and a shorter negotiation period. Interestingly, although close ties do not affect merger outcomes for shareholders; such ties help target directors by increasing their retention probability.

SEC settles with adviser over failure to consider account aggregation requests in applying fee breakpoint discounts

Purpose – To review SEC enforcement action taken against an adviser over: failure to grant advisory fee breakpoint discounts based on the aggregation of related accounts requested by clients and related deficiencies in the adviser’s administration of the account aggregation feature. Design/methodology/approach – Review and summarize the SEC’s finding’s regarding the adviser’s advisory fee breakpoint discount program, deficiencies in the program identified in SEC examinations, resulting violations of the Investment Advisers Act and its rules, the adviser’s remedial efforts and undertakings, and the sanctions imposed. Findings – This settlement provides an important reminder for registered investment advisers of the need to fully address deficiencies identified in SEC examinations and of the attention paid by SEC inspection staff to client fees as a core examination area. Originality/value – Practical explanation from experienced financial services lawyers.

How Much is Too Much? Large Termination Fees and Merger Outcomes

We investigate the use and impact of large target termination fees in acquisitions. Large termination fees are associated with more post-bid competition and lower completion rates, suggesting high fees do not effectively lock-in friendly bidders. Large termination fees are more common in deals with small and distressed targets and deals with high advisory fees. Switching regression estimates predict that high-fee deals would receive lower premiums with reduced termination fees. Overall, our evidence suggests that targets use large termination fees to overcome contracting problems when bidders face high transaction costs and information risk. In contrast to prior literature, there is limited evidence that managerial self-interest motivates high fees, as target managers in these deals are not more likely to receive severance packages or employment with the bidder in high-fee deals.

The role of investment banker directors in M&A

We examine how directors with investment banking experience affect firms׳ acquisition behavior. We find that firms with investment bankers on the board have a higher probability of making acquisitions. Furthermore, acquirers with investment banker directors experience higher announcement returns, pay lower takeover premiums and advisory fees, and exhibit superior long-run performance. Overall, our results suggest that directors with investment banking experience help firms make better acquisitions, both by identifying suitable targets and by reducing the cost of the deals.

Intermediation in the Market for Corporate Control

This paper analyzes the role of intermediation in the market for corporate control (mergers and acquisitions). I argue that given the decentralized nature of such market, financial intermediaries might help alleviating search frictions. A potential acquirer can search for acquisition targets directly or hire an intermediary to conduct the search. In equilibrium, the extent of the search friction depends not only on skill but also on the endogenous number of firms that can be acquired. I find that even when acquirers have a search advantage over intermediaries, an equilibrium where both types of search, intermediated and direct, coexist might arise. Moreover, the model characterizes the advisory industry and fees, rationalizes existing evidence on the role of advisors and provides new implications for the role and importance of intermediaries in aggregate M&A dynamics.

The Role of Equity Underwriting Relationships in Mergers and Acquisitions

We examine the role of the equity underwriting relationships in subsequent mergers and acquisitions (M&As). A firm, either the bidder or the target, tends to choose the financial advisors with which it has prior equity underwriting relationships in subsequent merger deals. Furthermore, the prior equity underwriting relationships are associated with lower advisory fees for target firms and with higher merger synergy gains for both acquiring and target firms. Thus, it pays to be loyal when a firm has a subsequent M&A deal. Overall, by exploring the relation between the prior equity underwriting relationships and subsequent M&A advisory, our study also contributes to partly provide a positive answer to the long-standing question of whether firms derive value from investment bank relationships in a different way.

Information Production by Investment Banks: Evidence from Fairness Opinions

AbstractWe analyze a direct product of the investment banking process: target firm valuations disclosed in the fairness opinions of negotiated mergers. On average, acquirer advisers exhibit positive valuation errors that are significantly greater than those of target advisers. Top-tier advisers produce more accurate valuations than lower tier advisers, but we find no relation between valuation accuracy and the contingency structure of advisory fees. The stock price reactions to merger announcements and to the public disclosure of target-sought fairness opinions are positively related to the difference between target firm valuations contained in the fairness opinion and the merger offer price. We conclude that investment banks produce information not previously available to market participants through the rendering of target-side fairness opinions.