Chapter 6
Transcript of Chapter 6
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Fund Manager Compensation
Cumming & Johan (2009, Chapter 6)
© Cumming & Johan (2009) Fund Manager Compensation
Chapter Motivation
• Size of venture capital markets per GDP differs significantly across developed and emerging markets
• Venture capital finance– Risk capital– Value-added active investors– Governance– Not diversified – Role of legal protections to mitigate idiosyncratic risk
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Venture capital investment by stages as a percentage of GDP, 1998-2001Source: OECD
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Chapter Objectives
• Understand how VC fund managers compensated differently across countries
• Fixed fees, Performance Fees, Clawbacks, Cash versus Share Distributions
• This is important, as compensation arrangements affect investment incentives and possibly performance
• First look at data on international differences in VC compensation arrangements
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Institutional andOther Investors
Venture Capital Funds
Entrepreneurial Firms
Fundraising Distributions (Cash versus Shares)Clawback of VC Fees
Supply ofInvestments
Demand forInvestments
Venture Capital IntermediationPensionPlanMembers(you and I)
Fixed FeesPerformance Fees
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Main Findings
1. Lower fixed fees in countries with stronger legal standards
2. Higher performance fees in countries with stronger legal standards
3. Lower probability of clawbacks in countries with stronger legal standards
4. Cash only distributions to institutional investors for offshore funds
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HypothesisData
Empirical TestsFuture Research
Conclusions
Hypotheses
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Human Capital
HypothesisData
Empirical TestsFuture Research
Conclusions
• Learning Model– Less experience greater fixed fees and
higher performance fees
• Signaling Model (less plausible)– Less experience lower fixed fees and higher
performance fees
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Legal and Institutional Conditions
HypothesisData
Empirical TestsFuture Research
Conclusions
• Learning Model
– The weaker the legal environment, the higher the fixed management fee percentage.
– The weaker the legal environment, the lower the carried interest performance fee percentage.
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Legal Environment and Institutional Investors
HypothesisData
Empirical TestsFuture Research
Conclusions
• The weaker the legal environment, the greater the probability that the institutional investors will mandate a clawback of fund manager fees in the event of poor fund performance.
• The weaker the legal environment, the greater the probability of covenants mandating cash-only distributions from fund managers to institutional investors.
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Offshore Funds
HypothesisData
Empirical TestsFuture Research
Conclusions
• Offshore funds are more likely to mandate cash-only distributions from fund managers to institutional investors.
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HypothesisData
Empirical TestsFuture Research
Conclusions
Data
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Data
HypothesisData
Empirical TestsFuture Research
Conclusions
• Survey directed to VC funds worldwide• 1000 distributed• 50 replies (5%)
• Small dataset– But extremely confidential details– And typical for VC research
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Profile of Countries Represented in the Dataset
HypothesisData
Empirical TestsFuture Research
Conclusions
Finland, 1Germany, 3
Italy, 1
Malaysia, 6
Netherland Antilles, 4Netherlands, 8
Philippines, 1South Africa, 2
UK, 6
US, 8
Switzerland, 1
New Zealand, 1
Belgium, 3
Luxembourg, 1
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Figure 6.1. Graphical Depiction of the Relation between Fees and Legal Conditions
Fixed Management Fee % Carried Interest Performance Fee %
Philippines Brazil
South Africa
MalaysiaItaly
CaymanIslands
Germany
NetherlandAntilles
UK
US
Belgium
CanadaFinland
New Zealand
Netherlands
LuxembourgSwitzerland
PhilippinesBrazil
SouthAfrica
Malaysia
Italy
CaymanIslands
GermanyBelgium
CanadaFinland
New Zealand
UK US
NetherlandAntilles
SwitzerlandLuxembourg
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HypothesisData
Empirical TestsFuture Research
Conclusions
Empirical Tests
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Multivariate Regressions
HypothesisData
Empirical TestsFuture Research
Conclusions
• OLS analyses of fixed and performance fees
• Logit Analyses of clawbacks and cash-only distributions
• Various sensitivity checks
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TABLE 6.4: ANALYSIS OF FIXED FEES
Model 1 Model 2 Model 3 Model 4 Model 5
Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic
Constant 9.644 4.361*** 11.273 5.582*** 8.446 4.548*** 11.071 6.133*** 21.211 0.708
Legal and Market Conditions
Country Legality Index -2.021 -2.913*** -3.993 -3.622*** -1.857 -3.250*** -3.883 -3.342*** -2.107 -2.561**
English Legal Origin -0.196 -0.711
French Legal Origin -0.132 -0.376
German Legal Origin -0.074 -0.151
GNP Per Capita 0.442 2.204** 0.416 1.731
MSCI Index -0.320 -1.066 -0.086 -0.241
Vintage Year of Fund -0.006 -0.413
Outbound Offshore Fund -0.684 -3.264***
Inbound Offshore Fund 0.258 1.506
Tax Difference -0.003 -0.531
Fund Manager Characteristics
Proportion of PhD (Science) Trained Fund Managers
-0.001 -0.257 -0.004 -0.867 -0.002 -0.399 -0.004 -1.045
Proportion of Legally Trained Fund Managers
-0.004 -0.721
Proportion of MBA/CFA Trained Fund Managers
-0.004 -0.950
Average # Years of Relevant Work Experience of Principal Fund Managers
0.268 1.322 0.213 1.016
Fund Characteristics
Funds Raised -0.133 -2.863*** -0.144 -2.834*** -0.121 -2.394** -0.131 -2.230** -0.096 -1.522
Bank Institutional Investors 0.272 0.527 0.130 0.274
Government Investors 0.600 2.796*** 0.667 2.172**
Limited Partnership Funds 0.021 0.161
Industry Market / Book -0.667 -2.580** -0.598 -2.338** -0.765 -3.092*** -0.700 -2.607***
Early Stage Investee Focus -0.238 -1.017
Adjusted R2 0.296 0.321 0.293 0.271 0.336
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TABLE 6.5: ANALYSIS OFPERFORMANCE FEES
Model 6 Model 7 Model 8 Model 9 Model 10
Coefficient
t-Statistic Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic
Constant -9.378 -1.106 -18.584 -1.904* -10.426 -0.971 -19.208 -1.705* -116.463 -0.503
Legal and Market Conditions
Country Legality Index 9.764 4.121*** 19.086 3.433*** 10.913 4.237*** 25.427 3.935*** 11.224 4.158***
English Legal Origin -2.754 -1.440
French Legal Origin -3.723 -1.953*
German Legal Origin -0.734 -0.321
GNP Per Capita -1.921 -1.645 -3.202 -2.544**
MSCI Index -1.261 -0.780 -2.095 -1.219
Vintage Year of Fund 0.050 0.433
Outbound Offshore Fund -0.325 -0.262
Inbound Offshore Fund -0.193 -0.120
Tax Difference -0.025 -0.623
Fund Manager Characteristics
Proportion of PhD (Science) Trained Fund Managers
0.028 1.757* 0.040 2.116** 0.019 1.121 0.039 1.372
Proportion of Legally Trained Fund Managers 0.063 1.405
Proportion of MBA/CFA Trained Fund Managers
-0.018 -0.855
Average # Years of Relevant Work Experience -0.971 -0.377 -1.383 -0.602
Fund Characteristics
Funds Raised -0.288 -0.923 -0.179 -0.543 -0.337 -1.039 -0.024 -0.057 0.002 0.004
Bank Institutional Investors 1.800 0.915 1.638 0.803
Government Investors 0.691 0.393 -0.595 -0.301
Limited Partnership Funds -0.800 -0.934
Industry Market / Book -0.562 -0.311 -0.894 -0.543 -0.490 -0.236 -0.453 -0.248
Early Stage Investee Focus 1.338 0.867
Adjusted R2 0.146 0.160 0.101 0.123 0.113
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TABLE 6.6: ANALYSIS OFCLAWBACKS
Model 11 Model 12 Model 13 Model 14 Model 15
Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic Coefficient t-StatisticCoeffici
entt-Statistic
Constant 25.662 2.737*** 22.344 2.262*** 27.365 2.411*** 34.319 2.209**-
731.895-1.636
Legal and Market Conditions
Country Legality Index -8.172 -2.836*** -4.762 -0.933 -10.657 -2.701*** -11.313 -2.559** -8.076 -2.666***
English Legal Origin -0.327 -0.151
GNP Per Capita -0.702 -0.765
MSCI Index -5.065 -1.984** -5.638 -1.714*
Vintage Year of Fund 0.378 1.689*
Offshore Fund (Inbound Offshore or Outbound Offshore)
-1.234 -1.121 -1.266 -1.139 -2.882 -1.836* -3.225 -1.581 -1.951 -1.480
Fund Manager Characteristics
Proportion of PhD (Science) Trained Fund Managers
-0.053 -0.935 -0.043 -0.831 -0.163 -1.685* -0.205 -1.587
Proportion of Legally Trained Fund Managers -0.034 -0.486
Proportion of MBA/CFA Trained Fund Managers
-0.036 -0.824
Average # Years of Relevant Work Experience of Principal Fund Managers
2.308 1.686* 2.131 1.335
Fund Characteristics
Funds Raised -0.087 -0.342 -0.060 -0.223 0.581 1.175 0.636 0.968 -0.424 -1.241
Bank Institutional Investors -7.590 -1.683* -11.000 -1.506
Government Investors 4.300 1.638 3.678 1.133
Limited Partnership Funds 0.882 0.835
Industry Market / Book -1.227 -0.945 -1.4418 -1.067 -2.487 -1.316 -3.266 -1.330
Early Stage Investee Focus -0.961 -0.944
Pseudo R2 0.286 0.296 0.523 0.542 0.337
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TABLE 6.7: ANALYSIS OF CASH VERSUS SHARE DISTRIBUTIONS
Model 16 Model 17 Model 18 Model 19 Model 20
Coefficient t-StatisticCoefficie
ntt-Statistic Coefficient t-Statistic
Coefficient
t-Statistic
Coefficient
t-Statistic
Constant 11.796 1.000 24.809 1.533 12.533 0.965 67.108 1.700* 16.609 0.060
Legal and Market Conditions
Country Legality Index -4.650 -1.193 -16.041 -1.615 -5.923 -1.428 -16.467 -1.728* -3.859 -0.965
English Legal Origin -4.548 -1.413
French Legal Origin
German Legal Origin
GNP Per Capita 2.195 1.310
MSCI Index 2.835 1.383 0.334 0.076
Vintage Year of Fund -0.004 -0.029
Offshore Fund (Inbound Offshore or Outbound Offshore)
3.478 3.141*** 3.729 3.205*** 3.895 2.715*** 7.261 2.121** 3.835 3.268***
Fund Manager Characteristics
Proportion of PhD (Science) Trained Fund Managers 0.019 0.584 0.019 0.610 0.040 1.074 -0.019 -0.196
Proportion of Legally Trained Fund Managers -0.147 -0.884
Proportion of MBA/CFA Trained Fund Managers -0.162 -1.274
Average # Years of Relevant Work Experience of Principal Fund Managers
0.917 0.703 0.695 0.296
Fund Characteristics
Funds Raised 0.494 1.329 0.328 0.896 0.531 1.102 0.589 0.914 0.529 1.152
Bank Institutional Investors -0.263 -0.141 -11.131 -0.982
Government Investors 0.776 0.308 -3.516 -0.633
Limited Partnership Funds -1.783 -1.241
Industry Market / Book -1.327 -0.846 -0.9942 -0.617 -1.452 -0.850 -6.243 -1.485
Early Stage Investee Focus -1.217 -1.034
Pseudo R2 0.466 0.497 0.512 0.702 0.505
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Future Research
HypothesisData
Empirical TestsFuture Research
Conclusions
Unanswered questions…
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Future Research (1)
HypothesisData
Empirical TestsFuture Research
Conclusions
• Performance fees and IRRs– Prior work on IRRs:
• US: Cochrane (2005 Journal of Financial Economics)• Worldwide: Cumming and Walz (2004 Working Paper)
– No data from any country exists whereby performance fees are matched to IRRs
• IF Performance fees high IRRs future fundraising• THEN countries with poor laws will continue to have difficulty
attracting future funds
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Future Research (2)
HypothesisData
Empirical TestsFuture Research
Conclusions
• Compensation and performance of other types of professional managers around the world– Mutual funds– CEOs– Etc.
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Future Research (3)
HypothesisData
Empirical TestsFuture Research
Conclusions
• Government subsidization of VC• Should government funds have performance fees for managers?• Appropriate levels of public support for government funds?
• Chapter 9 of this book– Evidence from Canada & Europe indicates pure government funds are
‘bad’ • Cumming and MacIntosh (2006 Journal of Business Venturing)• Armour and Cumming (2006 Oxford Economic Papers)• Cumming (2006 Journal of Business)
– Evidence from Australia and the US indicates mixed public / private government funds are ‘good’
• Lerner (1999 Journal of Business)• Cumming (2006 Journal of Business Venturing)
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Future Research (4)
HypothesisData
Empirical TestsFuture Research
Conclusions
• Taxation of compensation
• Taxation of options
• This is currently a very heavily debated issue in US and UK
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HypothesisData
Empirical TestsFuture Research
Conclusions
Conclusions
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Summary and Conclusions (1)
HypothesisData
Empirical TestsFuture Research
Conclusions
VC managerial compensation has 2 parts: Fixed fee Performance fee
Countries with bad laws are more likely to have: Higher fixed fees Lower performance fees
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Summary and Conclusions (2)
HypothesisData
Empirical TestsFuture Research
Conclusions
• Clawbacks (reductions in VC manager fees by institutional investors) are more likely in countries with bad laws
• Cash only distributions (instead of shares) to VC fund shareholders (institutional investors) more likely for offshore funds
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Summary and Conclusions (3)
HypothesisData
Empirical TestsFuture Research
Conclusions
IF Performance fees high IRRs future fundraising
THEN countries with poor laws will continue to have difficulty attracting future funds