High Water Marks in Hedge Fund Management Contracts

The thesis provides a theoretical rationale for the inclusion of high water mark (HWM) provisions in hedge fund management contracts. The results show (i) fund managers with better information about future fund profitability, have more incentives to efficiently close the fund it contracts include HWMs. (ii) Contracts with HWMs cause fund managers to smooth performance. HWMs provide both the incentive to underreport returns in good times as well as to overreport returns during difficult periods.