《Hedge Fund Governance Index paper》.pdf

Skin in the Game versus Skimming the Game: Governance, Share Restrictions, and Insider Flows Gideon Ozik and Ronnie Sadkay May 9, 2011 Abstract Hedge-fund managers justify share restrictions as a means of protecting the common interest of the shareholders. However, this paper demonstrates that such restrictions can adversely induce information asymmetry between managers and their clients about future fund áows. Focusing on share-restricted funds, this paper demonstrates that funds with recent outáows underperform funds with recent ináows by about 5.6% annually over 1998-2008. No such return spread is observed for funds with low-share restriction. The e§ect is mainly driven by the underperformance of funds with recent outáows. As managers may also act as investors in their own funds, the information asymmetry potentially allows them to trade in advance of their clients to avoid such losses. Consistent with this hypothesis, the áow return spread is more pronounced in funds managing insider wealth, as well as in funds with low levels of corporate governance. Even a conservative estimate of the potential proÖts from engaging in such activity amount to about $215 million per year collectively over the sample period. These results therefore highlight the signiÖcance of the recent SEC allegations of áow-front-running activity by hedge- fund insiders. JEL classiÖcation: G12; G14; G23; G34 Keywords: Hedge funds; Fund áows; Inside information; Asset pricing; Corporate Governance We would like to thank Pierluigi Balduzzi, Serge Darolles, RenÈ Garcia, Edith Hotchkiss, Byoung-Hyoun Hwang,