Essays on Financial Economics

Abstract

This dissertation studies the implications of financial intermediation focusing on the two subsectors of the asset management industry: mutual funds and venture capital. Chapter 1 analyzes the determinants of compensation of mutual fund portfolio managers. The portfolio manager compensation is influenced by fund flows driven by past raw returns. Managers are thus paid equally for fund superior performance and for the fund’s passive benchmark returns. We interpret these results though a model that combines trust-mediated money management in the spirit of Gennanioli, Shleifer and Vishny (2015) and imperfect labor market competition. In our model, compensation and fund size are jointly determined by expected raw returns and by the level of intermediary’s trustworthiness. Additional empirical evidence confirms the distinct model predictions. Chapter 2 studies the economics of trail commissions in the financial advisory industry. I exploit a policy experiment in Israel when mutual funds were subject to exogenous differential reductions in commissions. Commissions incentivize financial advisors to “steer” clients into high-commission products and they also increase prices reflecting an increase in mutual fund marginal costs. The reduction in commissions led to a reduction in fund expense ratios, accompanied by an increase in inflows as well as an increase in outflows. To reconcile these findings, I develop a model of portfolio choice and financial advice with investors exhibiting inertial behavior. My model helps to explain the main effects of the commissions and it predicts an increase in sensitivity of flows to past performance following the reform. These predictions are supported by the data. Chapter 3 examines the role investments by angel groups across a heterogeneous set of 21 countries with varying entrepreneurship eco-systems. Exploiting quasi-random assignment of deals around the groups’ funding thresholds, we find a positive impact of funding on firm growth, performance, survival and follow-on fundraising, which is independent of the level of venture activity and entrepreneur-friendliness in the country. However, the maturity of startups that apply for funding (and are ultimately funded) inversely correlates with the entrepreneurship-friendliness of the country. This may reflect self-censoring by early-stage firms that do not expect to receive funding in these environments.