Discussion Paper Details

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Title: The quality-assuring role of mutual fund advisory fees

Author(s): Michel Antoine Habib and D. Bruce Johnsen

Publication Date: February 2015

Keyword(s): advisory fees, closet indexing, excessive fees, open-access and quality-assurance

Programme Area(s): Financial Economics

Abstract: 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.

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Bibliographic Reference

Habib, M and Johnsen, D. 2015. 'The quality-assuring role of mutual fund advisory fees'. London, Centre for Economic Policy Research.