Do bonuses improve hedge fund manager performance?
Updated: May 4, 2020
A few years ago a NY hedge fund boss asked me a odd question. I thought it odd because I'm convinced he already knew how I would answer, and how he would respond to my answer. And both of us knew that nothing I said would make any to difference to the way he ran his business. The question was: What do you think of individual performance bonuses?
I immediately conceded that I had no evidence on which to base an opinion. No study I was aware of had tried to measure the impact of individual incentive payments on complex tasks like hedge fund management. Still, I insisted that all economic incentives send an implicit message, namely that good performance is not expected without it. This message might be acceptable in manual, routine jobs where it is clear that the worker is only doing it for the money. But, in creative, analytical tasks, where effort does not easily map to outcomes, the impact of incentives is less clear.
I also reminded him of the huge power of incentives. If he believes that teamwork is essential to long-term success, which he did, he should use individual incentives with caution. Also, if P&L is not the only measure of ‘good performance’ it should not be the only determinant for the incentive.
Well now a recent paper published by the Ludwig Maximillians University in Munich, describes a set of experiments designed to test the effect on group performance of incentive payments for non-routine, analytical tasks. The results reveal that team bonuses DO improve performance. The scientists also suggest that the means by which this is achieved is the team organization and the emergence of leadership. “Teams facing incentives are more likely to wish for a leader, and leaders appear to emerge endogenously when teams face incentives.”