Management fee base: financing and investment decisions

The aim of this paper is to focus on different compensation structures for real estate mutual fund Management Companies and assess whether management fees paid on either Net Asset Value (NAV) or Gross Asset Value (GAV) generate distorted incentives relative to those generated by performance fees paid on the market value of the fund.

To test whether management fees induce Management Companies to opportunistic behaviors, the relative effect of NAV- and GAV-based fees is compared over time using a plethora of econometric models.

It is found that Management Companies that are paid GAV-based fees start with higher leverage to expand assets under management, then, subsequently, drive leverage and over-investment down as fund maturity approaches to minimize the negative impact of negative NPV investments on the final market value of the fund and therefore on performance fees paid at maturity.

A dataset of Italian listed real estate mutual funds is used. While the Italian market can be considered an ideal setting for an empirical analysis, studies on other countries would make it possible to test implications of the model that are only weakly identified in our setting.

Results could be important when designing managerial contracts.

It is shown that Management Companies actively manage the size of their balance sheet to maximize fees, and that NAV-based fees produce effects similar to market-based fees in terms of managerial incentives.