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Outsourcing Mutual Fund Management: Firm Boundaries, Incentives, and Performance

Authors

  • JOSEPH CHEN,

  • HARRISON HONG,

  • WENXI JIANG,

  • JEFFREY D. KUBIK

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    • Chen is from the University of California at Davis, Hong is from Princeton University, Jiang is from Yale School of Management, and Kubik is from Syracuse University. We thank the Editor, Cam Harvey, and anonymous referees for making many valuable suggestions. We also thank Effi Benmelech, Patrick Bolton, Ned Elton, Oliver Hart, Bengt Holmstrom, Steven Grenadier, Dan Kessler, Arvind Krishnamurthy, Burton Malkiel, Oguzhan Ozbas, Clemens Sialm, Jeremy Stein, Jay Wang, Luigi Zingales, and seminar participants at Arizona State, Brigham Young University, Dartmouth College, Georgia State, Harvard-MIT Organizational Economics Seminar, HEC Montréal, Mitsui Life Symposium at University of Michigan, New York University, SUNY Binghamton, UCLA, UC Irvine, UC San Diego, University of Illinois, University of Minnesota, University of Utah, China International Conference on Finance, and the Western Finance Association Meetings for a number of insightful comments. Hong acknowledges support from an NSF Grant.


ABSTRACT

We investigate the effects of managerial outsourcing on the performance and incentives of mutual funds. Fund families outsource the management of a large fraction of their funds to advisory firms. These funds underperform those run internally by about 52 basis points per year. After instrumenting for a fund's outsourcing status, the estimated underperformance is three times larger. We hypothesize that contractual externalities due to firm boundaries make it difficult to extract performance from an outsourced relationship. Consistent with this view, outsourced funds face higher powered incentives; they are more likely to be closed after poor performance and excessive risk-taking.

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