Hurdle Rates and High-Watermarks: Incentives or Restrictions?

Abstract

We analyze how hedge fund attributes affect performance and the decision to offer a hurdle rate and high-watermark. Our results indicate that hurdle rate and high-watermark act as restrictions on fee collection rather than incentives. Hedge funds that take riskier positions are more likely to offer a hurdle rate and high watermark. Controlling for fund size, our results also suggest that hedge funds that collect high performance fees are more likely to outperform those that collect low performance fees. Using three different measures of hedge fund performance in our cross sectional analysis and taking into account the risk profiles associated with different investment strategies, we confirm our results.