Principal-agent theory suggests that a manager should be paid relative to a benchmark that removes the effect of market or sector performance on the firm’s own performance. Recently, it hasbeenarguedthatwedonotobservesuchindexationinthedatabecauseexecutivescanset pay in their own interests, that is, they can enjoy “pay for luck ” as well as “pay for performance”. We first show that this argument is incomplete. The positive expected return on stock markets reflects compensation for bearing systematic risk. If executives ’ pay is tied to market movements, they can only expect to receive the market-determined return for risk-bearing. This argument, however, assumes that executive pay is tied to bad luck as well as to good luck. If executives can truly influence the setting of their pay, they will seek to have their performance benchmarked only when it is in their interest, namely when the benchmark has fallen. Using industry benchmarks, we find that there is significantly less pay-for-luck when luck is down (in which case pay-for-luck would reduce compensation) than when it is up. These empirical results are robust to a variety of alternative hypotheses and robustness checks, and suggest that the average executive loses 25-45% less pay from bad luck than she gains from good luck. 2 1

We examine changes in equity mutual funds investment advisory contracts. There are substantial advisory compensation rate changes in both directions, with typical percentage rate shifts exceeding one-fourth. We find that rate increases are associated with superior past marketadjusted performance, whereas rate decreases reflect economies of scale associated with growth, and are not associated with extreme poor performance. There are within-family spillover effects. For example, superior (e.g., star) performance for individual funds is associated with rate increases for a family s other funds. We also document fee rate reductions post-2004 by family funds involved in market-timing scandals, but find no evidence of a spillover to the broader industry. This paper examines changes in equity mutual funds investment advisory contracts. Advisory contracts generally pay the advisor a fee which is a percentage of the fund s total net assets. Fees are substantial. The median annual fee is roughly 80 basis points in our sample, representing about half of total expenses. The paper is the first to document changes in the advisory rate specified in the contract, and to test hypotheses about changes in marginal compensation rates. Our analysis yields insights into price setting in the mutual fund industry, as

Viswanathan for their comments. An Agency Explanation of the Closed-End Fund Puzzles Closed-end funds have been a topic of interest among academics and professionals on five counts. First, they tend to sell above their net asset value at their commencement. Second, they start selling at a discount within a year. Third, this discount is volatile but mean-reverting. Fourth, the news of open-ending a fund reduces the discount although some discount persists till the actual event of open-ending. Fifth, the volatility of the return on a fund’s price is higher than the volatility of the return on its underlying net asset value. In this paper, we develop a dynamic agency model with a market friction that helps explain these empirical regularities. The agency conflict is that the manager does not want to return money even if he runs out of good investment opportunities because his compensation is proportional to the total assets under management. The market friction is the extraneous fund policy restriction on the manager’s trading strategies so that he may have to make suboptimal non-informational trades. Depending on the dominance of his informational gain and non-informational loss, we predict a systematic pattern of premiums and discounts.

If arbitrage is costly and noise traders are active, asset prices may deviate from fundamental values for long periods of time. We use a sample of 158 closed-end funds to show that noise-trader sentiment, as proxied by retail-investor flows, leads to fluctuations in the discount. Nevertheless, we reject the hypothesis that noise-trader risk is the cause of the long-run discount. Instead we find that funds which are more difficult to arbitrage have larger discounts, due to: (i) the censoring of the discount by the arbitrage bounds, and (ii) the freedom of managers to increase charges when arbitrage is costly. Faculty of Finance, City University Business School, London. We would like to thank the editor,

We survey 396 portfolio managers about the structure of their compensation. Overall, compensation packages are more likely to be “subjective and discretionary ” than “objective and formula-based. ” Firm success-factors such as firm profitability have more impact on bonuses than client success factors like investment performance. Differences in the structure of compensation across firms, clients, job-types, and manager characteristics reflect likely differences in the underlying contracting environments, especially differences in the difficulty of monitoring performance and exerting control. We thank John Biggs for connecting us with investment industry professionals well-versed in the challenges of compensating portfolio managers. We appreciate our conversations with William Shanahan, Vice President of Compensation at TIAA-CREF and with representatives of two compensation consulting firms- Adam Barnett, Managing Director at McLagan Partners and Kathryn Steele and Steve Unzicker with Capital Resource Advisors- on best practices in the industry. We received expert advice on the survey instrument from Diane DelGuercio, Daniel Bergstresser, Anna Pavlova, Bing Liang, and John Nagorniak. We thank the portfolio managers at Commerce Bank, A.G. Edwards, NISA Investment Advisors, and Bank of America for taking the survey and

meetings and Southern Finance Association meetings. We would also like to thank Donald Cassidy of Lipper Analytical Services for providing some of the data and Melissa Frye, Mehmet Ozbilgin and Yoon Song for excellent research assistance. A prior version of this paper was titled “Why do firms issue equity? Rights issues in the closed-end funds industry. ” Agency conflicts in closed-end funds: The case of rights offerings We study 120 rights offerings by closed-end funds over 1988-1998. On average, rights offerings are announced when funds trade at a premium. This premium turns into a discount over the course of the offering. The premium decline is more severe when the increases in investment advisor’s compensation are larger and when the fund uses affiliated broker-dealers to solicit subscriptions to the offer. A clinical analysis shows that rights offerings allow investment advisors to sidestep fee rebates and increase pecuniary benefits to affiliated entities. Overall, our results suggest the presence of significant conflicts of interests in rights offerings by closed-end funds. 1 I.