Mutual Fund Competition for Ranking: When Risk-Taking Comes with Managerial Effort

This study investigates theoretically and empirically mutual fund managers’ risk-taking behavior due to ranking objectives. We argue that managers can not only choose the riskiness of their portfolio but can also determine how hard to work (their effort). The combination of risk and effort depends on the interim performance gap and the effort cost level. Both interim winner and loser gamble by taking high risk and spending low effort when the interim performance gap is below a certain threshold. Only the interim loser gambles when the interim performance gap is small and the effort cost is sufficiently high. Otherwise, managers adopt the same choice of risk-effort. In many cases, high (low) risk-taking induces higher (lower) effort. Empirically, we find that managerial effort is strongly and positively linked to their risk-shifting level. The worst-performers behave differently from the others but are not necessarily riskier and lazier.