Incentive Contracts in Delegated Portfolio Management

Posted: 8 Dec 2009

See all articles by C. Wei Li

C. Wei Li

University of Iowa

Ashish Tiwari

University of Iowa

Multiple version iconThere are 2 versions of this paper

Date Written: November 2009

Abstract

This article analyzes optimal nonlinear portfolio management contracts. We consider a setting in which the investor faces moral hazard with respect to the effort and risk choices of the portfolio manager. The employment contract promises the manager: (i) a fixed payment, (ii) a proportional asset-based fee, (iii) a benchmark-linked fulcrum fee, and (iv) a benchmark-linked option-type “bonus” incentive fee. We show that the option-type incentive helps overcome the effort-underinvestment problem that undermines linear contracts. More generally, we find that for the set of contracts we consider, with the appropriate choice of benchmark it is always optimal to include a bonus incentive fee in the contract. We derive the conditions that such a benchmark must satisfy. Our results suggest that current regulatory restrictions on asymmetric performance-based fees in mutual fund advisory contracts may be costly.

JEL Classification: G11, G12, D82, D86

Suggested Citation

Li, C. Wei and Tiwari, Ashish, Incentive Contracts in Delegated Portfolio Management (November 2009). The Review of Financial Studies, Vol. 22, Issue 11, pp. 4681-4714, 2009, Available at SSRN: https://ssrn.com/abstract=1519269 or http://dx.doi.org/hhp013

C. Wei Li (Contact Author)

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business
Iowa City, IA 52242-1097
United States
319-335-0911 (Phone)
3193353690 (Fax)

Ashish Tiwari

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business, 108 PBB
Iowa City, IA 52242
United States
(319) 353-2185 (Phone)
(319) 335-3690 (Fax)

HOME PAGE: https://tippie.uiowa.edu/people/ashish-tiwari

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