The Interdependence between Mutual Fund Managers and Investors in Setting Fees

In the mutual fund industry, there is a unique endogeneity between managers and investors. If a manager wants to lower fees in the hopes of attracting investors, the investors will not react unless they believe the manager will maintain low fees for a period of time. A binding contract is one way for managers to signal their commitment to low fees. However, in practice, many mutual funds waive fees with no contractual agreement that they will continue to waive fees. We show in a theoretical framework that an equilibrium with waivers can arise without contracts as long as investors' are relatively inert and discount factors are high enough for manager's to care about future fees. Investors are not fooled by waivers and are fully informed of the manager's actions and ability. If past returns have information about future returns, waivers indirectly act as a performance-based salary.