Forbes – As David Rubenstein of Carlyle Group once succinctly remarked, \u201cIf you can make 20 percent of the profits on other people\u2019s money, you are going to make a lot of money if you are good at what you do.\u201d Never have truer words been spoken about the underlying structure and operation of incentives in the financial markets.<\/p>\n
Performance-based compensation can be viewed as a call option that permits a fund manager to benefit from a rise in the value of the fund. The purpose is to incentivise managers for absolute returns, rather than simply tracking (and periodically beating) a benchmark like the S&P 500 or the FTSE 100. However, performance fees and carried interest can also have a potentially negative influence on risk-taking. As overall performance of a fund declines, for example, a particularly greedy fund manager may be motivated in the short term to increase the risk of investments to move his call option back \u201cin-the-money\u201d. Steps can be taken, however, to mitigate this risk-taking behaviour.<\/p>\n