The impact of management structure on hedge funds' performance and misreporting

Abstract

This study investigates the association of management structure with hedge fund performance and misreporting. Much management literature supports the belief that teams enjoy several advantages over their individual peers in collecting and integrating information and correcting errors. Since hedge fund managers are strongly incentivized and flexible to implement risky investment strategies, the performance implication of management structure should be more easily observable in hedge funds than in mutual funds and other industrial firms. Using hedge fund data over the period 2001 to 2011, I find that team-managed hedge funds exhibit higher future returns than individual-managed funds, which is consistent with theoretical predictions. The correlation between team management and hedge fund performance is present most strongly among funds with long team tenure, or funds that adopt relatively innovation-oriented investment styles such as global macro and multi-strategy. The association is particularly pronounced during bullish market periods. Next, I focus on team-managed funds and explore how school-ties within a team is related team performance. Cohen et al. (2008) supports the role of shared school ties as an influential information channel between mutual fund managers and company boards. It is therefore reasonable to conjecture that the more connections a fund team has through its alumni network, the more private information the fund can obtain from senior officers of firms. Such groups should enjoy access to a wider information set and be able to generate superior returns. This assertion is consistent with the information and decision-making hypothesis. However, similarity and social-categorization hypotheses have emphasized an increase in interpersonal liking, and communication in homo-groups due to shared background among members. My results show a negative implication of within-fund school ties on fund performance, especially in volatile periods or in two-manager teams. Risk-taking behavior may also be influenced by management structure and composition. Findings in this study are in line with group shift theory according to which teams conform to the opinions of dominating members and converge to take risky decisions ultimately. The association is pronounced among teams with strong intra-team school-ties. Furthermore, unlike the result from mutual funds, hedge funds with single-manager are found to attract more capital flows and display a lower probability to fail. Lastly, I examine return manipulation behaviors across hedge funds with different management structures. My findings support a mitigation role of team management in unethical behavior. Multi-manager funds are found to be less likely to engage in misreporting. Meanwhile, my results show no evidence of an enhancement of such association in teams with highly coherent members. My findings also have implications for practitioners. It may be of help to regulators while they target funds with a higher likelihood of engaging in fraud; investors can incorporate the widely available biographical information into their decision-making process while picking funds to invest in.