One puzzling feature of domestic private equity (PE) funds in emerging markets is that such funds often have a “short fuse”, i.e., a much shorter lifespan than their developed market counterparts. Based on a simple agency model, we propose an explanation for this puzzle. We show that, under a long fuse, PE managers have incentives to game performance-based compensation schemes by opportunistically timing investments and burning money when early investments fail. Shortening the fuse restricts timing opportunism, but alleviates money-burning incentives only if managerial compensation is sufficiently concavified or the contract stipulates substantial investors' hurdle returns. Both of these options can force managers to concede rents to investors. Thus, managers face a tradeoff between rents and agency costs. In emerging markets, where agency costs are high, managers use a short fuse with incentive compatible compensation schemes to minimize agency costs. In contrast, in developed markets, where agency costs are low, managers use a long fuse to preserve rents. Based on these results, we further draw predictions on fund performance, managerial behavior, and investor rents for both long-fused developed-market funds and short-fused emerging-market funds. We also predict that, when institutional infrastructure in emerging markets improves and when domestic PE managers in emerging markets gain more experience, domestic PE funds in emerging markets will adopt the long-lifespan PE contracts typical in developed markets.

Commercial banks in China issued a multitude of wealth management products (WMPs) from 2009 to 2016. These products are largely short-term, but a significant proportion of capital is allocated to long-term investments. In this paper, we first construct a measure of WMP maturity mismatch for each bank in each quarter using R2s from regressing expected yields of WMPs on expected yields of banks’ generally claimed investment assets. The degree of maturity mismatch is positively related to banks’ quarter-end non-performing loan ratio (NPLR), after accounting for time-varying bank characteristics, bank and time fixed effects. The result indicates that severer mismatch is associated with reduced NPLR. Cross-sectionally, the positive relation is stronger in big banks and when banks had a larger NPLR in the previous quarter. The results highlight the fact that regulated commercial banks use financial innovation and exploit maturity mismatch in their issued WMPs to evade regulator's credit risk monitoring.

We examine the extent to which institutional investors herd in the U.S. corporate bond market and the price impact of their herding behavior. We find that the level of institutional herding in corporate bonds is substantially higher than what is documented for equities, and that sell herding is much stronger and more persistent than buy herding. The price impact of herding is also highly asymmetric. While buy herding facilitates price discovery, sell herding causes transitory yet large price distortions. Such price destabilizing effect of sell herding is particularly pronounced for speculative-grade, small, and illiquid bonds, and during the financial crisis.