Post by Brown Goetzmann Liang on Nov 23, 2009 22:18:07 GMT 4
Trust and Delegation
Stephen J. Brown
NYU Stern School of Business
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
Bing Liang
University of Massachusetts at Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
Christopher Schwarz
University of California at Irvine
November 11, 2009
Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1504382_code2321.pdf?abstractid=1456414&mirid=2
Stephen J. Brown
NYU Stern School of Business
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
Bing Liang
University of Massachusetts at Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
Christopher Schwarz
University of California at Irvine
November 11, 2009
Abstract:
Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1504382_code2321.pdf?abstractid=1456414&mirid=2