Incentive Fees Research Articles

An incentive regulation approach for balancing stakeholder interests in transmission merchant investment

The merchant-regulatory mechanism represents a promising tool that combines the benefits of merchant investment and regulated investment, thereby providing efficient incentives for merchant Transmission Companies (Transcos) subject to regulatory compliance. Taking the H-R-G-V mechanism as a foundational example of this approach, it permits Transcos to receive the total surplus increase from investments, and the profit-maximizing Transco will perform social welfare maximum investment under this mechanism. However, one drawback of this mechanism is that it allows the Transco to receive the whole benefit created by the Transco, while excluding consumers and generators from the resultant economic benefits. To address this issue, we propose an incentive tuning parameter, which is incorporated into the calculation of the incentive fee for the Transco. Accordingly, the regulatory framework can effectively manage the Transco’s profit and allow market participants to access economic benefits, thus ensuring a fair distribution of economic advantages among the stakeholders, while the impact on overall social welfare remains relatively modest. The results on the case study demonstrate that this careful balancing act maintains the essence of the H-R-G-V mechanism while addressing its critical gap—the equitable sharing of economic gains.

Hedge fund fee structure and risk exposure

We provide a closed-form solution for the optimal investment strategy of a hedge fund manager compensated by a management fee and a high-water mark (HWM) contract. The fraction of the assets under management (AUM) allocated to equity is an increasing and convex function of distance to the HWM, with the size of the incentive fee rate enhancing the convexity effect. Importantly, the management fee induces more risk-taking behavior because it provides insurance to the fund manager. Beating the HWM by small amounts is optimal because it mitigates the ratchet feature of the HWM and smooths revenue. The decomposition of revenues between the two fee types is also examined. An extension introduces fund termination triggered by a large AUM drawdown. Risk exposure is either a decreasing or a hump-shaped function of the distance to the HWM.

Association of a Heart Failure Management Incentive in Primary Care With Clinical Outcomes: A Retrospective Cohort Study.

We aim to examine the association between primary care physicians' billing of Q050A, a pay-for-performance heart failure (HF) management incentive fee code, and the composite outcome of mortality, hospitalization, and emergency department visits. This population-based cohort study linked administrative health databases in Ontario, Canada, for patients with HF aged >66 years between January 1, 2008, and March 31, 2020. Cases were patients with HF who had a Q050A fee code billed. Cases and controls were matched 1:1 on age, sex, patient status on being rostered to a primary care physician, cardiologist, or internist visit in the 6 months before study enrollment, Johns Hopkins Adjusted Clinical Group resource use bands, days between HF diagnosis and study enrollment (±2 years), and the logit of the propensity score. A Cox proportional hazards model assessed the association of Q050A with the outcome. A total of 59 664 cases had a Q050A billed, whereas 244 883 patients did not. Before matching, patients who had a Q050A billed were more likely to be men (52% versus 49%), were rostered to a primary care physician (100% versus 96%), had a higher Charlson Comorbidity Index, and had higher health care costs. The mean follow-up was 481 days for cases and 530 days for controls. The composite outcome (hazard ratio, 1.11 [95% CI, 1.09-1.12]) was significantly higher for cases than controls. The Q050A incentive improved financial compensation for primary care physicians managing patients with HF but was not associated with improvements in the outcome. Research on promoting evidence-based HF management is warranted.

Benchmark-based strategy for minimizing Riskiness

This study develops an optimal benchmark-based strategy for determining the optimal managed portfolio weight vector by minimizing the Riskiness (proposed by Aumann and Serrano [2008]) of active portfolio returns. First, for increasing and concave incentive fees, this study confirms that no other active portfolio returns have greater utility than those generated using this optimal strategy; this finding is applicable for all risk-averse fund managers and institutional investors. Second, the optimal managed portfolio weight vector is derived and can be estimated through method-of-moments estimation. Finally, this study empirically identifies the statistical characteristics of this optimal strategy.

Decreasing returns to scale and skill in hedge funds

In this paper, we investigate value creation by hedge funds using Berk and van Binsbergen's (2015) value-added. We find that, on average, hedge fund managers extract $0.76 million dollars per month from the market. We provide strong evidence of persistence in value creation by hedge fund managers. Of three skill indicators—skill ratio, fee ratio, and total compensation—we find that total compensation best identifies the skilled manager out-of-sample. Investors in value-creating funds benefit from a more favourable risk–return payoff. While hedge funds typically operate in a less competitive market than mutual funds, our findings suggest that incentive fees do not indicate greater skill. The value that hedge funds can extract from the market depends on both the profitability and scalability of their investment strategies.

Optimal investment under high-water mark contracts with model ambiguity

This paper incorporates the ambiguities of the risky asset and the exogenous shock to explore how the two ambiguities influence the hedge funds model. We find the ambiguity of the risky asset makes the manager more risk averse and invest less. While the ambiguity of the exogenous shock induce the manager adopt radical investment way and invest more. But at the lower and upper bounds, both ambiguities do not work any more. The manager’s total value is eroded by either of the two ambiguities. Although the manager adopts different investment strategies for the two ambiguities, her income makes little difference. In high uncertain context of the external shock or the risky asset, manager’s rigorous investment strategies can protect the values of the investors and the entire fund. Both of the ambiguities have negative influences on the incentive fee and also reduce the proportion of incentive fee in her total income.

Investment Decision of Blockchain Technology in Fresh Food Supply Chains Considering Misreporting Behavior

Effectively managing fresh food supply chains (FFSCs) has long been a big challenge owing to the complexity in practice. Adoption of innovative technologies, blockchain traceability (BT), and cold-chain preservation (CP) technology to improve the efficiency of FFSC management has attracted much attention practically and academically. Distinct from existing studies, this paper provides a specific insight into the application of these two technologies by taking into account their functions in restraining misreporting behavior with BT technology due to its traceability and transparency and improving the freshness with CP technology based on the investment in fresh preservation equipment. With this in mind, this paper develops game theoretic models to identify the conditions under which technologies are the optimal selection for the supplier/retailer. It assumes that the retailer is the Stackelberg leader and the supplier is the follower. The key findings show that: (1) with the foci to eliminate suppliers’ misreporting behavior and minimize the incentive fees, BT investment can increase prices and promote order quantities and demand; (2) only when the consumers demonstrate “appropriate” sensitivity to freshness, a win–win situation can be achieved without adoption of BT technology; and (3) suppliers are not keen to invest in BT or CP technology when the circulation time is short, while retailers prefer to invest in CP technology when the circulation time is long.

Risking or Derisking: How Management Fees Affect Hedge Fund Risk-Taking Choices

AbstractHedge fund managers’ risk-taking choices are influenced by their compensation structure. We differ from most studies that focus on incentive fees and the high-water mark by examining how management fees affect managers’ risk-taking. Our simple model shows that managers’ risk-taking is negatively related to their future management fees. Using fund-level data, we find that future management fees are the dominant component of managers’ total compensation. When the contribution of future management fees increases, managers reduce risk-taking to increase survival probabilities. Moreover, funds with higher decreasing returns to scale are more sensitive to future management fees and reduce risk-taking even more.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

The Golden Mean: The Risk‐Mitigating Effect of Combining Tournament Rewards with High‐Powered Incentives

The rewards received by financial managers depend on both relative performance - e.g., fund infows based on league table rankings, executive promotions based on peer comparisons - and absolute performance - e.g., bonus payments for meeting accounting targets, hedge-fund incentive fees. It is well known that both relative and absolute performance rewards engender risk taking. In this paper, we show that these two sources of risk taking, relative and absolute performance rewards, mollify the risk-taking incentives produced by the other: absolute performance rewards mitigate rank-motivated risk taking. Rank rewards mitigate risk taking motivated by absolute performance rewards.

Incentive Fees with a Moving Benchmark and Portfolio Selection under Loss Aversion

L’objectif de cet article est d’étudier, dans un cadre unifié et dynamique, l’impact de la rémunération des gestionnaires de fonds (commission de performance symétrique ou non-symétrique avec potentiellement un malus), ainsi que leur propre investissement dans le fond lorsqu’ils sont caractérisés par une fonction d’utilité de type « aversion aux pertes ». Contrairement à la littérature existante, la performance du fond est appréciée par rapport à une référence (un indice, par exemple) risquée. Les principales conclusions de notre modèle et de nos simulations sont les suivantes : (i) une référence risquée modifie sensiblement l’allocation d’actifs ; (ii) les proportions optimales sont moins risquées dans le cas d’une commission de performance symétrique ; (iii) la détention par le gestionnaire d’une part relativement importante (30%) du fonds altère son comportement risqué et permet d’obtenir une valeur terminale du portefeuille quasi-identique quel que soit le type de rémunération ; (iv) les proportions optimales sont sensibles aux variations des valeurs des paramètres ; (v) ces résultats peuvent avoir des conséquences sur la régulation.

Practical Applications of On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives

<b>In</b><b><i>On the Valuation of Performance Fees and Their Impact on Managers’ Incentives</i></b>, from the Summer 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Wei Dai</b> and <b>Savina Rizova,</b> both at <b>Dimensional Fund Advisors</b>,and <b>Robert C. Merton</b> at the <b>MIT Sloan School of Management</b>, remind investors that performance fees can be valued using option pricing theory. Several researchers have applied an option-based approach to the valuation of hedge fund fees and other alternative investments’ performance fees, but few, if any, have done so for long-only systematic managers. The lack of research in that space is mostly because US legislation in the early 1970s banned mutual funds from charging asymmetric incentive fees. Recently, however, more managers of long-only, systematic, separately managed accounts are charging performance fees. The authors, therefore, focus on these types of accounts while illustrating how to use option pricing theory to value a wide variety of performance fee structures. Increased adoption of performance fees in long-only managed accounts coincides with investors’ increased interest in long-only systematic strategies.

A method development of incentive fee for ship equipment scheduled repair

A method development of incentive fee for ship equipment scheduled repair

Practical Applications of On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives

<b>In</b><b><i>On the Valuation of Performance Fees and Their Impact on Managers’ Incentives</i></b>, from the Summer 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Wei Dai</b> and <b>Savina Rizova,</b> both at <b>Dimensional Fund Advisors</b>,and <b>Robert C. Merton</b> at the <b>MIT Sloan School of Management</b>, remind investors that performance fees can be valued using option pricing theory. Several researchers have applied an option-based approach to the valuation of hedge fund fees and other alternative investments’ performance fees, but few, if any, have done so for long-only systematic managers. The lack of research in that space is mostly because US legislation in the early 1970s banned mutual funds from charging asymmetric incentive fees. Recently, however, more managers of long-only, systematic, separately managed accounts are charging performance fees. The authors, therefore, focus on these types of accounts while illustrating how to use option pricing theory to value a wide variety of performance fee structures. Increased adoption of performance fees in long-only managed accounts coincides with investors’ increased interest in long-only systematic strategies.

Practical Applications of On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives

<b>In</b><b><i>On the Valuation of Performance Fees and Their Impact on Managers’ Incentives</i></b>, from the Summer 2021 issue of <b><i>The Journal of Alternative Investments</i></b>, <b>Wei Dai</b> and <b>Savina Rizova,</b> both at <b>Dimensional Fund Advisors</b>,and <b>Robert C. Merton</b> at the <b>MIT Sloan School of Management</b>, remind investors that performance fees can be valued using option pricing theory. Several researchers have applied an option-based approach to the valuation of hedge fund fees and other alternative investments’ performance fees, but few, if any, have done so for long-only systematic managers. The lack of research in that space is mostly because US legislation in the early 1970s banned mutual funds from charging asymmetric incentive fees. Recently, however, more managers of long-only, systematic, separately managed accounts are charging performance fees. The authors, therefore, focus on these types of accounts while illustrating how to use option pricing theory to value a wide variety of performance fee structures. Increased adoption of performance fees in long-only managed accounts coincides with investors’ increased interest in long-only systematic strategies. <b>TOPICS:</b>Real assets/alternative investments/private equity, manager selection, options, performance measurement

Peritoneal dialysis in Indonesia: Current status, challenges and prospects.

Despite an increase in incident peritoneal dialysis (PD) use of 20% per year, the overall PD prevalence in Indonesia is only 1-2%, with the goal of 30% yet to be reached by 2019. In the absence of contraindications, increasing continuous ambulatory PD (CAPD) use may be an attractive option for Indonesia to reduce the high costs of end-stage kidney disease (ESKD) treatment. The implementation of CAPD in Indonesia faces several challenges, including the cost of PD, the unique archipelagic geography, limited facilities and trained medical personnel in rural areas, inadequate reimbursement rates and incentive fees, high rates of PD discontinuation, as well as insufficient knowledge regarding CAPD by the general public and health professionals. Changes in the policy of medical service incentive fees and improvements in the national health insurance system regulation over CAPD may improve the utilization of PD for ESKD patients in Indonesia. Nationwide promotional and preventive efforts on chronic kidney disease, dialysis modality education and establishment of PD training programs for medical professionals are necessary.

APhA, others file federal lawsuit against HHS to close DIR loophole

APhA, others file federal lawsuit against HHS to close DIR loophole

Practical Applications of An Inconvenient Fact:Private Equity Returns and the Billionaire Factory

In <b>An Inconvenient Fact: <i>Private Equity Returns and the Billionaire Factory</i></b>, from the December 2020 issue of The <b><i>Journal of Investing</i></b>, author <b>Ludovic Phalippou</b> (of the <b>Saïd Business School</b> at the <b>University of Oxford</b>) challenges the perception that private equity (PE) provides institutional investors with higher returns that justify its higher fees. PE is not available to the general public—and since PE investments are not continuously traded, there are no publicly available measures of PE rates of return. Therefore, PE firms use internal rate of return (IRR) as their primary advertised performance measure. However, a more appropriate measure of PE performance is based on a net present value (NPV) calculation, such as the public market equivalent (PME). Using this performance measure, Phalippou shows that US PE has produced about the same net-of-fees returns as the most common US stock indexes since 2006. Meanwhile, a small number of PE managers have become billionaires by receiving incentive fees based on absolute performance, not performance relative to any benchmark. The author questions who really benefits from PE investing, explains why pension funds and universities continue to embrace it, and offers suggestions to make PE investing more sustainable. <b>TOPICS:</b>Private equity, statistical methods, performance measurement

The Effect of External Audits: Evidence from Voluntary Audits of Hedge Funds

SYNOPSIS Using the setting of hedge funds, we document two important merits of external audits. We find that incentive fee rates (i.e., performance-based compensation to fund managers) are higher for audited funds than for unaudited funds. In contrast, management fee rates (i.e., fund-size-based compensation to fund managers) do not differ depending on audit status. We also find some evidence that audited funds attract more capital inflows from investors than unaudited funds do after funds report high performance. Our findings indicate that hedge fund investors appreciate the value of external audits.

An Inconvenient Fact:Private Equity Returns and the Billionaire Factory

In <b>An Inconvenient Fact: <i>Private Equity Returns and the Billionaire Factory</i></b>, from the December 2020 issue of The <b><i>Journal of Investing</i></b>, author <b>Ludovic Phalippou</b> (of the <b>Saïd Business School</b> at the <b>University of Oxford</b>) challenges the perception that private equity (PE) provides institutional investors with higher returns that justify its higher fees. PE is not available to the general public—and since PE investments are not continuously traded, there are no publicly available measures of PE rates of return. Therefore, PE firms use internal rate of return (IRR) as their primary advertised performance measure. However, a more appropriate measure of PE performance is based on a net present value (NPV) calculation, such as the public market equivalent (PME). Using this performance measure, Phalippou shows that US PE has produced about the same net-of-fees returns as the most common US stock indexes since 2006. Meanwhile, a small number of PE managers have become billionaires by receiving incentive fees based on absolute performance, not performance relative to any benchmark. The author questions who really benefits from PE investing, explains why pension funds and universities continue to embrace it, and offers suggestions to make PE investing more sustainable. <b>TOPICS:</b>Private equity, statistical methods, performance measurement

Deciphering Private Equity Incentive Contracting and Fund Leverage Choice

I explain the standard carried interest contract as a mechanism to induce incentive compatible fund leverage while also satisfying LP return objectives. Fee, leverage and target return data from private equity real estate (PERE) funds are used to calibrate the model. Steps in the modeling process include developing a tradeoff model of fund capital structure that pits alpha against the costs of financial distress. Financial distress costs are shown to create endogenous upper bounds on fund debt levels. GPs with convex incentive fee payoff functions limit debt, even in the absence of distress costs. I also analyze how catch-up fee provisions arise endogenously to generate larger fees for high-skill fund managers.