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Abstract: 

Hedge fund governance matters to investors because better governance can lead to higher returns. Governance matters to managers because better governance can help managers raise and retain capital. The growing focus on governance, combined with the increasing number of hedge funds competing for capital, has resulted in greater bargaining power for investors concerning fees and other governance devices. This article provides a comprehensive analysis of the internal governance of hedge funds. The primary components of hedge fund governance are investors with a high propensity to exercise their short-term redemption rights; managers with high pay-performance sensitivity, because they are being compensated with an annual performance-based fee plus earnings from their own investment in the funds they manage; sophisticated investors who demand quality governance; and short-term creditors and derivatives counterparties who provide close monitoring. Hedge fund governance needs the most improvement in the areas of performance reporting (valuation) and the timing of performance-fee calculations. Further, counterintuitively, in some circumstances investors may benefit from less disclosure, higher fees, and less access to their capital.

Keywords: management compensation; performance fees; fiduciary duty; lockups; incentive misalignments; high water marks; hurdle rates; redemption restrictions

Affiliations:  1: New York Law School.