TY  - JOUR
AU  - Brown,Stephen
AU  - Goetzmann,William
AU  - Liang,Bing
AU  - Schwarz,Christopher
TI  - Trust and Delegation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15529
PY  - 2009
Y2  - November 2009
UR  - http://www.nber.org/papers/w15529
L1  - http://www.nber.org/papers/w15529.pdf
N1  - Author contact info:
Stephen J. Brown
Stern School of Business
New York University
New York, NY 10012
Tel: 718 273 0317
Fax: 718 981 7239
E-Mail: sbrown@stern.nyu.edu

William N. Goetzmann
School of Management
Yale University
Box 208200
New Haven, CT 06520-8200
Tel: 203/432-5950
Fax: 203/432-3003
E-Mail: william.goetzmann@yale.edu

Bing Liang
Isenberg School of Management
University of Massachusetts Amherst
Amherst, MA 01002
Tel: (413) 545-3180
Fax: (413) 545-3858
E-Mail: bliang@isenberg.umass.edu

Christopher Schwarz
University of California at Irvine
Irvine, CA 92697-3125
E-Mail: cschwarz@uci.edu
AB  - Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An operational risk score based on information contained in the DD reports significantly predicts subsequent fund failure and statistical performance characteristics out of sample. Finally we find that observed operational risk characteristics do not appear to moderate fund flow.
ER  -