Compensation of portfolio managers tied to firm profitability more than client success, survey shows

April 30, 2004 -- As the Securities and Exchange Commission debates new rules that would require mutual funds to disclose how fund portfolio managers are compensated, research by two scholars at the Olin School of Business at Washington University in St. Louis shows that money manager pay is more influenced by the success of their firm than the investment performance of their clients. The survey of portfolio managers finds that firm success-factors such as firm profitability have more impact on portfolio managers' bonuses than client success factors like investment performance, though managers are more likely to be dismissed for poor investment performance.

Heber Farnsworth

Heber Farnsworth and Jonathan Taylor, assistant professors of finance at the Washington University business school, polled money managers at SEC registered investment advisory firms and present their survey findings in new research entitled, "Evidence on the Compensation of Portfolio Managers." The result is the first detailed examination of the incentives faced by money managers. About 400 portfolio managers responded to the survey.

The survey indicates that over 45 percent of a portfolio manager's compensation is due to their bonus. More than 44 percent of the money managers responding to the survey said their firm's overall profits have the largest impact on their bonus, greater than any other incentive, including their client's investment performance. Tax efficiency and risk control were ranked as the lowest incentive by the portfolio managers. The median manager polled in the survey manages $435 million in investments.

Jonathan Taylor

"Firm success factors such as firm profitability, flows and new business, have much more impact on bonuses than client success factors like investment performance, tax efficiency, and risk control," Farnsworth and Taylor note. Yet, they also find evidence that firms use the threat of dismissal to align managerial incentives with the client.

Farnsworth and Taylor's research shows that differences in the structure of money managers' compensation across firms, clients, job-types, and manager characteristics reflect differences in the underlying contracting environments, especially differences in the difficulty of monitoring performance and exerting control.

"Money managers in environments where monitoring is difficult have more performance-sensitive contracts," the two note in their research. "Managers serving clients who can not easily assert control over the assets they've entrusted to the manager's firm have more performance-sensitive contracts."