Unearned Performance Fees

This paper provides a new paradigm for thinking about performance fees. Closed-form expressions for the value and expected value of the performance fee for a popular generic structure are presented. The expected fee is decomposed into earned and unearned components. Suggestions for reducing the expected unearned performance fee are provided. It is shown that the expected unearned performance fee can be reduced substantially with simple procedures. Finally, it is shown for another popular fee structure that the expected unearned performance fee can be negative for talented managers. The paradigm is easily generalized to other performance fee structures