Hedge Fund Regulation and Misreported Returns

Douglas J. Cumming · Na Dai

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Auditing, Earnings Management, Governance Financial Markets and Investment Strategies Corporate Finance and Governance

Abstract

Abstract This paper introduces a cross‐country law and finance analysis of the misreporting behaviour in the hedge fund industry in terms of smoothing returns so that a fund consistently generates positive returns. We find strong evidence that international differences in hedge fund regulation are significantly associated with the propensity of fund managers to misreport monthly returns. We find a positive association between wrappers and misreporting, particularly for funds that do not have a lockup provision. Also, we find some evidence that misreporting is less common among funds in jurisdictions with minimum capitalisation requirements and restrictions on the location of key service providers. We assess the robustness of our finds to a number of specifications, including, different specifications of misreporting bin widths, subsets of the data by fund type, as well as specifications controlling for collinearity and selection effects and other robustness checks. We show misreporting significantly affects capital allocation, and calculate the wealth transfer effects of misreporting and relate this wealth transfer to differences in hedge fund regulation.

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References

1998Law and Finance 2001Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature 2000Investor protection and corporate governance 2002Investor Protection and Corporate Valuation 1997Earnings management to avoid earnings decreases and losses 2006What Works in Securities Laws?1999Earnings Management to Exceed Thresholds 2004Earnings quality in UK private firms: comparative loss recognition timeliness

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2013Are hedge fund managers systematically misreporting? Or not?2017Developments in financial institutions, governance, agency costs, and misconduct 2016The Valuation of Hedge Funds’ Equity Positions 2010Hedge Fund Return Misreporting: Incentives and Effects 2015Regulatory Oversight and Return Misreporting by Hedge Funds 2019Hedge Fund Regulation and Fund Governance: Evidence on the Effects of Mandatory Disclosure Rules

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