Too Much “Skin in the Game” Ruins the Game: Evidence From Managerial Capital Gains Taxes

Co-investment, often seen as a remedy for agency problems, may also incentivize asset managers to cater to their private interests. We find evidence that mutual fund managers with substantial co-investment stakes adjust their risk-taking to prioritize private tax considerations. Using the enactment of the American Taxpayer Relief Act of 2012 as an exogenous shock to managerial capital gains taxes, we show that managers with above-median co-investment significantly increase portfolio risk relative to those with below-median stakes. This effect does not appear to be driven by classical agency incentives. Instead, co-investing managers shift risk by tilting portfolios toward higher beta exposure, leading to a deterioration in fund performance. Our findings highlight co-investment as a transmission mechanism through which manager-level tax shocks affect fund-level portfolio decisions.

Bührle, Theresa and Chia-Yi Yen (2023), Too Much “Skin in the Game” Ruins the Game: Evidence From Managerial Capital Gains Taxes, ZEW Discussion Paper No. 23-028, Mannheim.