Gaming Performance Fees By Portfolio Managers

Dean P. Foster and H. Peyton Young

Editor’s Note: A PDF of the full paper can be downloaded at The Quarterly Journal of Economics website.


We show that it is very difficult to devise performance-based compensation contracts that reward portfolio managers who generate excess returns while screening out managers who cannot generate such returns. Theoretical bounds are derived on the amount of fee manipulation that is possible under various performance contracts.We show that recent proposals to reform compensation practices, such as postponing bonuses and instituting clawback provisions, will not eliminate opportunities to game the system unless accompanied by transparency in managers’ positions and strategies. Indeed, there exists no compensation mechanism that separates skilled from unskilled managers solely on the basis of their returns histories.