The Agency Costs of Side‐by‐side Management: Evidence from the Hedge Fund and Private Equity Industry

Abstract This paper examines the impact of the simultaneous management of private equity on hedge fund performance. We derive theoretical predictions based on bounded rationality theory and agency theory. We first examine the firm characteristics driving the side‐by‐side decision. We show that the ‘side‐by‐side’ managed hedge funds underperform their peers. The underperformance is more pronounced when the side‐by‐side managed funds have different styles, when they perform worse in the previous year and when they are younger and have a smaller size. To establish causal interpretation, we conduct a full sample regression analysis, a Heckman selection model, a PSM analysis, entropy‐balanced matching and a set of placebo tests. Overall, our results suggest that side‐by‐side management distracts firm‐level fund managers’ time and attention, weakens advising and monitoring and distorts the fund performance. Diversification beyond expertise may not always benefit investors.