1. © Cumming & Johan (2013)Fund Manager Compensation Cumming & Johan (2013, Chapter 6) 1

2. © Cumming & Johan (2013)Fund Manager Compensation Chapter Motivation Size of venture capital markets per GDP differs significantly across developed and emerging markets Venture capital finance – Risk capital – Value-added active investors – Governance – Not diversified – Role of legal protections to mitigate idiosyncratic risk 2

3. © Cumming & Johan (2013)Fund Manager Compensation 3

4. © Cumming & Johan (2013)Fund Manager Compensation Chapter Objectives Understand how VC fund managers compensated differently across countries Fixed fees, Performance Fees, Clawbacks, Cash versus Share Distributions This is important, as compensation arrangements affect investment incentives and possibly performance First look at data on international differences in VC compensation arrangements 4

5. © Cumming & Johan (2013)Fund Manager Compensation Institutional and Other Investors Venture Capital Funds Entrepreneurial Firms Fundraising Distributions (Cash versus Shares) Clawback of VC Fees Supply of Investments Demand for Investments Venture Capital Intermediation Pension Plan Members (you and I) Fixed Fees Performance Fees 5

6. © Cumming & Johan (2013)Fund Manager Compensation Main Findings 1.Lower fixed fees in countries with stronger legal standards 2.Higher performance fees in countries with stronger legal standards 3.Lower probability of clawbacks in countries with stronger legal standards 4.Cash only distributions to institutional investors for offshore funds 6

7. © Cumming & Johan (2013)Fund Manager Compensation Hypothesis Data Empirical Tests Future Research Conclusions Hypotheses 7

8. © Cumming & Johan (2013)Fund Manager Compensation Human Capital Hypothesis Data Empirical Tests Future Research Conclusions Learning Model – Less experience  greater fixed fees and higher performance fees Signaling Model (less plausible) – Less experience  lower fixed fees and higher performance fees 8

9. © Cumming & Johan (2013)Fund Manager Compensation Legal and Institutional Conditions Hypothesis Data Empirical Tests Future Research Conclusions Learning Model – The weaker the legal environment, the higher the fixed management fee percentage. – The weaker the legal environment, the lower the carried interest performance fee percentage. 9

10. © Cumming & Johan (2013)Fund Manager Compensation Legal Environment and Institutional Investors Hypothesis Data Empirical Tests Future Research Conclusions The weaker the legal environment, the greater the probability that the institutional investors will mandate a clawback of fund manager fees in the event of poor fund performance. The weaker the legal environment, the greater the probability of covenants mandating cash-only distributions from fund managers to institutional investors. 10

11. © Cumming & Johan (2013)Fund Manager Compensation Offshore Funds Hypothesis Data Empirical Tests Future Research Conclusions Offshore funds are more likely to mandate cash-only distributions from fund managers to institutional investors. 11

12. © Cumming & Johan (2013)Fund Manager Compensation Hypothesis Data Empirical Tests Future Research Conclusions Data 12

13. © Cumming & Johan (2013)Fund Manager Compensation Data Hypothesis Data Empirical Tests Future Research Conclusions Survey directed to VC funds worldwide 1000 distributed 50 replies (5%) Small dataset – But extremely confidential details – And typical for VC research 13

14. © Cumming & Johan (2013)Fund Manager Compensation Profile of Countries Represented in the Dataset Hypothesis Data Empirical Tests Future Research Conclusions 14

15. © Cumming & Johan (2013)Fund Manager Compensation 15

16. © Cumming & Johan (2013)Fund Manager Compensation Hypothesis Data Empirical Tests Future Research Conclusions Empirical Tests 16

17. © Cumming & Johan (2013)Fund Manager Compensation Multivariate Regressions Hypothesis Data Empirical Tests Future Research Conclusions OLS analyses of fixed and performance fees Logit Analyses of clawbacks and cash-only distributions Various sensitivity checks 17

18. © Cumming & Johan (2013)Fund Manager Compensation TABLE 6.4: ANALYSIS OF FIXED FEES Model 1Model 2Model 3Model 4Model 5 Coefficientt-StatisticCoefficientt-StatisticCoefficientt-StatisticCoefficientt-StatisticCoefficientt-Statistic Constant9.6444.361***11.2735.582***8.4464.548***11.0716.133***21.2110.708 Legal and Market Conditions Country Legality Index-2.021-2.913***-3.993-3.622***-1.857-3.250***-3.883-3.342***-2.107-2.561** English Legal Origin -0.196-0.711 French Legal Origin -0.132-0.376 German Legal Origin -0.074-0.151 GNP Per Capita 0.4422.204** 0.4161.731 MSCI Index -0.320-1.066-0.086-0.241 Vintage Year of Fund -0.006-0.413 Outbound Offshore Fund -0.684-3.264*** Inbound Offshore Fund 0.2581.506 Tax Difference-0.003-0.531 Fund Manager Characteristics Proportion of PhD (Science) Trained Fund Managers -0.001-0.257-0.004-0.867-0.002-0.399-0.004-1.045 Proportion of Legally Trained Fund Managers -0.004-0.721 Proportion of MBA/CFA Trained Fund Managers -0.004-0.950 Average # Years of Relevant Work Experience of Principal Fund Managers 0.2681.3220.2131.016 Fund Characteristics Funds Raised-0.133-2.863***-0.144-2.834***-0.121-2.394**-0.131-2.230**-0.096-1.522 Bank Institutional Investors 0.2720.5270.1300.274 Government Investors 0.6002.796***0.6672.172** Limited Partnership Funds 0.0210.161 Industry Market / Book-0.667-2.580**-0.598-2.338**-0.765-3.092***-0.700-2.607*** Early Stage Investee Focus -0.238-1.017 Adjusted R 2 0.2960.3210.2930.2710.336 18

19. © Cumming & Johan (2013)Fund Manager Compensation TABLE 6.5: ANALYSIS OF PERFORMANCE FEES Model 6Model 7Model 8Model 9Model 10 Coefficie nt t-StatisticCoefficientt-StatisticCoefficientt-StatisticCoefficientt-StatisticCoefficientt-Statistic Constant-9.378-1.106-18.584-1.904*-10.426-0.971-19.208-1.705*-116.463-0.503 Legal and Market Conditions Country Legality Index9.7644.121***19.0863.433***10.9134.237***25.4273.935***11.2244.158*** English Legal Origin -2.754-1.440 French Legal Origin -3.723-1.953* German Legal Origin -0.734-0.321 GNP Per Capita -1.921-1.645 -3.202-2.544** MSCI Index -1.261-0.780-2.095-1.219 Vintage Year of Fund 0.0500.433 Outbound Offshore Fund -0.325-0.262 Inbound Offshore Fund -0.193-0.120 Tax Difference-0.025-0.623 Fund Manager Characteristics Proportion of PhD (Science) Trained Fund Managers 0.0281.757*0.0402.116**0.0191.1210.0391.372 Proportion of Legally Trained Fund Managers 0.0631.405 Proportion of MBA/CFA Trained Fund Managers -0.018-0.855 Average # Years of Relevant Work Experience -0.971-0.377-1.383-0.602 Fund Characteristics Funds Raised-0.288-0.923-0.179-0.543-0.337-1.039-0.024-0.0570.0020.004 Bank Institutional Investors 1.8000.9151.6380.803 Government Investors 0.6910.393-0.595-0.301 Limited Partnership Funds -0.800-0.934 Industry Market / Book-0.562-0.311-0.894-0.543-0.490-0.236-0.453-0.248 Early Stage Investee Focus 1.3380.867 Adjusted R 2 0.1460.1600.1010.1230.113 19

20. © Cumming & Johan (2013)Fund Manager Compensation TABLE 6.6: ANALYSIS OF CLAWBACKS Model 11Model 12Model 13Model 14Model 15 Coefficientt-StatisticCoefficientt-StatisticCoefficientt-StatisticCoefficientt-Statistic Coeffici ent t-Statistic Constant25.6622.737***22.3442.262***27.3652.411***34.3192.209** - 731.895 -1.636 Legal and Market Conditions Country Legality Index-8.172-2.836***-4.762-0.933-10.657-2.701***-11.313-2.559**-8.076-2.666*** English Legal Origin -0.327-0.151 GNP Per Capita -0.702-0.765 MSCI Index -5.065-1.984**-5.638-1.714* Vintage Year of Fund 0.3781.689* Offshore Fund (Inbound Offshore or Outbound Offshore) -1.234-1.121-1.266-1.139-2.882-1.836*-3.225-1.581-1.951-1.480 Fund Manager Characteristics Proportion of PhD (Science) Trained Fund Managers -0.053-0.935-0.043-0.831-0.163-1.685*-0.205-1.587 Proportion of Legally Trained Fund Managers -0.034-0.486 Proportion of MBA/CFA Trained Fund Managers -0.036-0.824 Average # Years of Relevant Work Experience of Principal Fund Managers 2.3081.686*2.1311.335 Fund Characteristics Funds Raised-0.087-0.342-0.060-0.2230.5811.1750.6360.968-0.424-1.241 Bank Institutional Investors -7.590-1.683*-11.000-1.506 Government Investors 4.3001.6383.6781.133 Limited Partnership Funds 0.8820.835 Industry Market / Book-1.227-0.945-1.4418-1.067-2.487-1.316-3.266-1.330 Early Stage Investee Focus -0.961-0.944 Pseudo R 2 0.2860.2960.5230.5420.337 20

21. © Cumming & Johan (2013)Fund Manager Compensation TABLE 6.7: ANALYSIS OF CASH VERSUS SHARE DISTRIBUTIONS Model 16Model 17Model 18Model 19Model 20 Coefficientt-Statistic Coefficie nt t-StatisticCoefficientt-Statistic Coefficie nt t- Statistic Coefficie nt t-Statistic Constant11.7961.00024.8091.53312.5330.96567.1081.700*16.6090.060 Legal and Market Conditions Country Legality Index-4.650-1.193-16.041-1.615-5.923-1.428-16.467-1.728*-3.859-0.965 English Legal Origin -4.548-1.413 French Legal Origin German Legal Origin GNP Per Capita 2.1951.310 MSCI Index 2.8351.3830.3340.076 Vintage Year of Fund -0.004-0.029 Offshore Fund (Inbound Offshore or Outbound Offshore) 3.4783.141***3.7293.205***3.8952.715***7.2612.121**3.8353.268*** Fund Manager Characteristics Proportion of PhD (Science) Trained Fund Managers0.0190.5840.0190.6100.0401.074-0.019-0.196 Proportion of Legally Trained Fund Managers -0.147-0.884 Proportion of MBA/CFA Trained Fund Managers -0.162-1.274 Average # Years of Relevant Work Experience of Principal Fund Managers 0.9170.7030.6950.296 Fund Characteristics Funds Raised0.4941.3290.3280.8960.5311.1020.5890.9140.5291.152 Bank Institutional Investors -0.263-0.141-11.131-0.982 Government Investors 0.7760.308-3.516-0.633 Limited Partnership Funds -1.783-1.241 Industry Market / Book-1.327-0.846-0.9942-0.617-1.452-0.850-6.243-1.485 Early Stage Investee Focus -1.217-1.034 Pseudo R 2 0.4660.4970.5120.7020.505 21

22. © Cumming & Johan (2013)Fund Manager Compensation Future Research Hypothesis Data Empirical Tests Future Research Conclusions Unanswered questions… 22

23. © Cumming & Johan (2013)Fund Manager Compensation Future Research (1) Hypothesis Data Empirical Tests Future Research Conclusions Performance fees and IRRs – Prior work on IRRs: US: Cochrane (2005 Journal of Financial Economics) Worldwide: Chapter 22 of this book – No data from any country exists whereby performance fees are matched to IRRs IF Performance fees  high IRRs  future fundraising THEN countries with poor laws will continue to have difficulty attracting future funds 23

24. © Cumming & Johan (2013)Fund Manager Compensation Future Research (2) Hypothesis Data Empirical Tests Future Research Conclusions Compensation and performance of other types of professional managers around the world – Mutual funds – CEOs – Etc. 24

25. © Cumming & Johan (2013)Fund Manager Compensation Future Research (3) Hypothesis Data Empirical Tests Future Research Conclusions Government subsidization of VC Should government funds have performance fees for managers? Appropriate levels of public support for government funds? Chapter 9 of this book – Evidence from Canada indicates pure government funds are ‘bad’ Cumming and MacIntosh (2006 Journal of Business Venturing) Cumming (2006 Journal of Business) – Evidence from Australia and the US indicates mixed public / private government funds are ‘good’ Lerner (1999 Journal of Business) Cumming (2007 Journal of Business Venturing) 25

26. © Cumming & Johan (2013)Fund Manager Compensation Future Research (4) Hypothesis Data Empirical Tests Future Research Conclusions Taxation of compensation Taxation of options This is currently a very heavily debated issue in US and UK 26

27. © Cumming & Johan (2013)Fund Manager Compensation Hypothesis Data Empirical Tests Future Research Conclusions 27

28. © Cumming & Johan (2013)Fund Manager Compensation Summary and Conclusions (1) Hypothesis Data Empirical Tests Future Research Conclusions  VC managerial compensation has 2 parts:  Fixed fee  Performance fee  Countries with bad laws are more likely to have:  Higher fixed fees  Lower performance fees 28

29. © Cumming & Johan (2013)Fund Manager Compensation Summary and Conclusions (2) Hypothesis Data Empirical Tests Future Research Conclusions Clawbacks (reductions in VC manager fees by institutional investors) are more likely in countries with bad laws Cash only distributions (instead of shares) to VC fund shareholders (institutional investors) more likely for offshore funds 29

30. © Cumming & Johan (2013)Fund Manager Compensation Summary and Conclusions (3) Hypothesis Data Empirical Tests Future Research Conclusions  IF Performance fees  high IRRs  future fundraising  THEN countries with poor laws will continue to have difficulty attracting future funds 30