Implicit Incentives and Reputational Herding by Hedge Fund Managers

Several theories of reputation suggest that managers' incentives affect their propensity to engage in herding behavior. This paper investigates these theories by tracking hedge fund managers' herding behavior over their careers. I first examine managerial incentives for herding, and show that more senior managers that deviate from the herd have a significantly higher probability of failure and do not experience higher fund inflows than their less-senior counterparts. These implicit incentives should encourage managers to herd more as their careers progress. I find strong support for this hypothesis: using a number of proxies for herding, I show that more experienced managers herd more than less-experienced managers. Finally, I examine performance differences between more and less-experienced managers, and find that while more experienced managers underperform less-experienced managers, this underperformance does not appear to be caused by differences in herding. Overall, these results are in direct contrast with studies of mutual fund managers, reflecting important difference in implicit incentives between the two industries