Veteran investor Charlie Munger once quipped, “Show me the incentive, and I'll show you the outcome.” Put simply, what metrics an employer uses to determine performance pay will likely have a profound effect on the way employees behave. In turn, that impacts how companies perform.

A recently published study of mutual fund managers’ performance shows how Munger’s thought comes to life in the real world of finance. And it demonstrates that significantly different outcomes occur when employees get paid to compete against each other — versus when they are compensated for cooperating.

So What’s the Best Method?

The best answer will depend on the goals of the company, says Darden Professor Rich Evans, who recently co-authored a paper on the matter in the Journal of Financial Economics. The overall findings of the research have far-reaching implications that go beyond the world of finance.
Mutual fund companies that encourage competition between employees tend to have a higher portion of star funds, according to the paper “Competition and Cooperation in Mutual Fund Families.” Evans conducted the research with Melissa Porras Prado of the Nova School of Business and Economics and Rafael Zambrana of the University of Notre Dame.

Not only did the competitively minded firms have more star funds, they had higher average fund performance. The overall fund performance in a family of funds would be higher when fund managers were pitted against each other in a competition to perform the best.

However, encouraging competition between employees came with a downside. There was a higher variation in fund returns: The difference in investment returns between the best and worst performers was wider than when companies encouraged cooperation between employees.

The research also showed that firms that fostered cooperation had more cross-trading and cross-holdings of securities, and they tended to have more stable cash flows, the study explains.

A Slew of Data

To make these findings, the authors analyzed a slew of data. They looked at returns on five distinct types of mutual funds over the period 1992 to 2015. Specifically, those types of funds were: those that managed domestic stocks, non-U.S. stocks, domestic bonds, non-U.S. bonds and balanced portfolios with multiple asset classes held. They then dug deep into how the portfolio managers got paid. Statistics on expenses, fund returns and portfolio turnover were analyzed, as was the level of cross-holdings between mutual funds in the same fund family.

The authors also constructed a competitive index, which measures how the incentives encouraged higher or lower levels of competition. The authors found that higher competitive indexes correlated with higher performance of the funds, and vice versa.

So Why Cooperate?

With Wall Street’s reputation for fierce competition, why would a finance leader choose a cooperative approach rather than a competitive one?

“If the objective is to maximize the overall value of an investment adviser, coordinated action among fund managers may be an important tool to accomplish this objective,” the report states. The study found that “cooperative incentives were associated with lower volatility,” in advisory fees. These fees form the revenue of the company. And investors tend to view stable cash flow favorably.

So which compensation system is better? “That question is valid for any organization,” Evans says. “Do you want everyone competing or do you want them cooperating?” In the case of fund companies, Evans says the questions come down to who the clients are and how big the organization is.

Different Strokes for Different Investors

Evans notes that for institutional clients, a competitive approach makes sense because sophisticated institutional investors are interested in gaining access to the skill and acumen of an individual fund manager. For instance, a pension fund might want to invest with a particular fund because its manager has a history of superior performance. Institutional investors have the expertise to be able to discern which managers are better than others, Evans explains.

Contrast that with a financial advisory firm whose clients are individuals. “Cooperative [fund] families ... are more likely to manage retail investor assets,” the research paper says. The demand for mutual funds from individual investors is less sensitive to the performance of the investment. Instead, other characteristics, such as the relationship with a financial adviser, may hold more sway.

Size matters also when it comes to which compensation system to use. In smaller companies, there is less to be gained by cooperation. The individual fund managers may each have investment specialties that do not overlap. And therefore the scope for gains for working cooperatively are lessened. However, with larger organizations, there are certainly gains to be had from cooperation, Evans explains. That's because even what may seem like a small advantage in performance with one manager may mean a gain that can multiply many times over when a company has a large array of fund offerings.


These findings are also relevant outside the mutual fund world. The competition element is relevant in the sales world in which individuals’ skills can make a big difference in how many dollars they bring in from customers. A good example might be a real estate sales professional with specific knowledge of a local market.

The size element is also applicable to other industries. A massive automobile company spanning multiple continents would surely benefit from cooperation between departments. Even small efficiency gains in one factory can quickly be shared across the company and benefit the entire organization, ultimately boosting profits significantly. “Cooperative incentives work when you are big, because you have so many sources for possible improvement that can be shared widely across the organization,” Evans says.

Richard B. Evans co-authored “Competition and Cooperation in Mutual Fund Families, which appeared in the Journal of Financial Economics, with Melissa Porras Prado of the Nova School of Business and Economics and Rafael Zambrana of the University of Notre Dame’s Mendoza College of Business.

About the Expert

Richard B. Evans

Donald McLean Wilkinson Professor of Business Administration

Professor Evans’ research and teaching focus is investment decision-making. He explores risk taking by mutual fund managers, the role of broker intermediation in mutual fund investing, the impact of commission bundling and other trading costs on portfolio performance and retail and institutional-investor behavior.

Evans has been cited by The New York TimesThe Wall Street Journal and Forbes magazine and published in the top finance journals: Journal of FinanceReview of Financial Studies and the Journal of Financial Economics. He has also taught Executive Education courses for investment professionals from Merrill Lynch, Morgan Stanley and Citizens Bank.

B.S., M.S., University of Utah; M.A., Ph.D., Wharton School, University of Pennsylvania