Review of behavioral explanations of how rank-based incentives influence risk taking by investment managers in mutual fund companies

Abstract

Purpose The purpose of this paper is to review behavioral explanations of the empirical observation that investment managers in mutual fund companies increase their risk taking when offered incentives based on how their performance is ranked compared to peers. Design/methodology/approach A conceptual model is proposed of how research on social comparison, competition and financial risk taking may explain increased investor risk taking induced by rank-based incentives. Research findings in each of the strands of research are reviewed. Findings A proposed main explanation is that an above-average bias in comparing oneself with competitors results in overconfidence that increases risk taking. A complementary proposed explanation is that an anticipated loss when lagging behind increases risk taking, and another proposed complementary explanation the belief that risk taking is a winning strategy. Originality/value The results provide a broad framework for directions of research on social comparison processes in the mutual fund industry addressing the difficulties in implementing performance evaluations.