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The rewards received by financial managers depend on both relative performance (e.g., fund inflows based on fund rankings, promotions based on peer comparisons) and absolute performance (e.g., bonus payments for meeting accounting targets, hedge-fund incentive fees). Both relative and absolute performance rewards engender risk-taking. In this paper, we show that these two sources of risk-taking, relative and absolute performance rewards, mitigate the risk-taking incentives produced by the other. This mutual incentive-reduction effect generates a number of novel predictions about the relationship of managerial risk-taking with the structure of relative and absolute performance rewards.

How can fragility be averted in open-end mutual funds? In recent years, markets have observed an innovation that changed the way open-end funds are priced. Alternative pricing rules (known as swing pricing) adjust funds’ net asset values to pass on funds’ trading costs to transacting shareholders. Using unique data on investor-level transactions in U.K. corporate bond funds, we show that swing pricing eliminates the first-mover advantage arising from the traditional pricing rule and significantly reduces outflows during market stress. Swing pricing also reduces concavity in the flow-performance relationship and dilution in fund performance.