Hedge Fund Investor Is A Prince; Hedge Fund Manager Is A Governor.

Hedge Fund Investor Is A Prince; Hedge Fund Manager Is A Governor.

—-Newest Model for Hedge fund regulation from Roger B. Myerson.*

[My conversation with him occurred on April 24, 2008, Cambridge MA.]

As Roger says, he “consider[s] a model of governors serving a sovereign prince, who wants to deter them from corruption and rebellion.” In hedge fund world, I consider a model of hedge fund managers managing their investors’ money, who want to deter them from fraud and excessive risk.

In Roger’s article, “governors must be penalized when they cause observable crises, but a governor’s expected benefits must never go below the rebellion payoff, which itself is better than what any candidate could pay for the office.” In hedge fund industry, I think hedge fund managers have to be penalized when they cause obvious crises, but a hedge fund manager’s expected benefits must never go below the performance fee, which itself is much higher than the performance fee they could get from fraud.

According to Roger, “governors can trust the prince’s promises only up to a given credit bound.” In hedge fund world, I guess hedge fund managers can have faith in the investors’ loyalty only up to a given credit bound as well.

This paper goes on and on, and the content of the paper provides an alternative approach to regulate or self-regulate the hedge fund industry. He mainly use “an extension of the Becker-Stigler and Sharpiro-Stiglitz dynamic agency models” to address the issues with regard to “judging and punishing high officials of the state,”, which can be used to hedge fund managers as well.

 

As Roger Myerson writes, “For high officials to be deterred from abusing their power, they must be confident that loyal service will bring great expected rewards.” In hedge fund industry, I argue that in order to prevent hedge fund managers from defrauding investors, fund managers have to be confident that their honest disclosure will be greatly compensated.

Even though he did not mention hedge fund, this is a good model to consider in hedge fund industry.

*Roger B. Myerson, the 2007 Nobel Laureate in Economics. “Leadership, Trust, And Power: Dynamic Moral Hazard In High Office,” April 2008. <home.uchicago.edu/~rmyerson/research/power.pdf>

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