Gaming Performance Fees by Portfolio Managers

Any compensation mechanism that is intended to reward superior investment performance can be gamed by managers who have no superior information or predictive ability; moreover they can capture a sizable amount of the fees intended for the superior managers. We derive precise bounds on the size of this coat‐tail effect and show that it remains substantial even when payments are postponed, bonuses are subject to clawback provisions, or outright penalties are imposed for poor performance. This impossibility result stands in contrast to performance measures, some of which are invulnerable to manipulation.