Too much "skin in the game" ruins the game : evidence from managerial capital gains taxes

Co-investment, often seen as a remedy for agency problems, may incentivize managers to cater to own preferences. We provide evidence that mutual fund managers with considerable co-investment stakes alter risk-taking decisions to prioritize their own tax interests. By exploiting the enactment of the American Taxpayer Relief Act 2012 as an exogenous shock of managerial capital gains taxes, we observe that co-investing fund managers increase risk-taking by 8%. Specifically, these managers adjust their portfolios by investing in stocks with higher beta. The observed effect appears to be driven by agency incentives, particularly for funds with a more convex flow-performance relationship and for managers who have underperformed. Such tax-induced behavior is associated with negative fund performance. We highlight the role of co-investment in transmitting managerial tax shocks to mutual funds.