© cumming & johan (2013)fund manager compensation cumming & johan (2013, chapter 6) 1

© Cumming & Johan (2013) Fund Manager Compensation

Fund Manager Compensation

Cumming & Johan (2013, Chapter 6)

1


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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Icel

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Uni

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King

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Swed

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Belg

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Finl

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Irela

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Fran

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Spai

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Switz

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Portu

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Italy

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Gre

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Aust

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Pola

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Cze

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Hun

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Slov

ak R

epub

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Kore

a (1

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Aust

ralia

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New

Zea

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Japa

n (1

995-

2000

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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


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


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


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


Conclusions

• Offshore funds are more likely to mandate cash-only distributions from fund managers to institutional investors.

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HypothesisData


Conclusions

Data

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Data

HypothesisData


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


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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0 5 10 15 20 25

Fix

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Fe

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Fe

e (%

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Legality Index

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


Conclusions

Empirical Tests

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Multivariate Regressions

HypothesisData


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


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


Country Legality Index 9.764 4.121*** 19.086 3.433*** 10.913 4.237*** 25.427 3.935*** 11.224 4.158***


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



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


-0.018 -0.855

Average # Years of Relevant Work Experience -0.971 -0.377 -1.383 -0.602


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 0.11319


TABLE 6.6: ANALYSIS OFCLAWBACKS


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


Country Legality Index -8.172 -2.836*** -4.762 -0.933 -10.657 -2.701*** -11.313 -2.559** -8.076 -2.666***


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



-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


-0.036 -0.824


2.308 1.686* 2.131 1.335


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



Pseudo R2 0.286 0.296 0.523 0.542 0.337 20


TABLE 6.7: ANALYSIS OF CASH VERSUS SHARE DISTRIBUTIONS


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


Country Legality Index -4.650 -1.193 -16.041 -1.615 -5.923 -1.428 -16.467 -1.728* -3.859 -0.965


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***


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


0.917 0.703 0.695 0.296


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



Pseudo R2 0.466 0.497 0.512 0.702 0.505 21


Future Research

HypothesisData


Conclusions

Unanswered questions…

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Future Research (1)

HypothesisData


Conclusions

• Performance fees and IRRs– Prior work on IRRs:

• US: Cochrane (2005 Journal of Financial Economics)• Worldwide: Chapter 22 of this book

– 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


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


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 indicates pure government funds are ‘bad’

• Cumming and MacIntosh (2006 Journal of Business Venturing)• 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 (2007 Journal of Business Venturing)

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Future Research (4)

HypothesisData


Conclusions

• Taxation of compensation

• Taxation of options

• This is currently a very heavily debated issue in US and UK

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HypothesisData


Conclusions

Conclusions

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Summary and Conclusions (1)

HypothesisData


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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HypothesisData


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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HypothesisData


Conclusions

IF Performance fees high IRRs future fundraising

THEN countries with poor laws will continue to have difficulty attracting future funds

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© cumming & johan (2013)fund manager compensation cumming & johan (2013, chapter 6) 1

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