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High-Water Marks and Hedge Fund Management Contracts


  • William N. Goetzmann,

  • Jonathan E. Ingersoll Jr.,

  • Stephen A. Ross

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    • Goetzmann and Ingersoll are at the Yale School of Management. Ross is at the Sloan School of Management at MIT. We thank Stephen Brown, Judy Chevalier, Bruce Lehmann, N. Prabhala, and two anonymous referees for helpful comments and discussion. We also thank participants in the 1998 NBER Asset Pricing Workshop and the 1998 WFA meetings.


Incentive fees for money managers are frequently accompanied by high-water mark provisions that condition the payment of the performance fee upon exceeding the previously achieved maximum share value. In this paper, we show that hedge fund performance fees are valuable to money managers, and conversely, represent a claim on a significant proportion of investor wealth. The high-water mark provisions in these contracts limit the value of the performance fees. We provide a closed-form solution to the cost of the high-water mark contract under certain conditions. Our results provide a framework for valuation of a hedge fund management company.

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