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Review of behavioral explanations of how rank-based incentives influence risk taking by investment managers in mutual fund companies

Tommy Gärling (Department of Economics and Centre for Finance, Goteborgs Universitet, Goteborg, Sweden)
Dawei Fang (Department of Economics and Centre for Finance, Goteborgs Universitet, Goteborg, Sweden)
Martin Holmen (Department of Economics and Centre for Finance, Goteborgs Universitet, Goteborg, Sweden)

Review of Behavioral Finance

ISSN: 1940-5979

Article publication date: 21 August 2019

Issue publication date: 12 June 2020

Abstract

Purpose

The purpose of this paper is to review behavioral explanations of the empirical observation that investment managers in mutual fund companies increase their risk taking when offered incentives based on how their performance is ranked compared to peers.

Design/methodology/approach

A conceptual model is proposed of how research on social comparison, competition and financial risk taking may explain increased investor risk taking induced by rank-based incentives. Research findings in each of the strands of research are reviewed.

Findings

A proposed main explanation is that an above-average bias in comparing oneself with competitors results in overconfidence that increases risk taking. A complementary proposed explanation is that an anticipated loss when lagging behind increases risk taking, and another proposed complementary explanation the belief that risk taking is a winning strategy.

Originality/value

The results provide a broad framework for directions of research on social comparison processes in the mutual fund industry addressing the difficulties in implementing performance evaluations.

Keywords

Acknowledgements

This research is financially supported by Grant No. 2010-02449 to the Centre for Finance, School of Business, Economics, and Law, University of Gothenburg, Göteborg, Sweden, from the Swedish Governmental Agency for Innovation Systems, and grant 2015-01713 to Martin Holmen from the Swedish Research Council.

Citation

Gärling, T., Fang, D. and Holmen, M. (2020), "Review of behavioral explanations of how rank-based incentives influence risk taking by investment managers in mutual fund companies", Review of Behavioral Finance, Vol. 12 No. 2, pp. 136-150. https://doi.org/10.1108/RBF-01-2019-0013

Publisher

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Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited