Incentive Contracts in Delegated Portfolio Management

41 Pages Posted: 22 Mar 2007 Last revised: 3 Mar 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: May 1, 2008

Abstract

This paper analyzes optimal non-linear portfolio management contracts. We consider a setting where the investor faces moral hazard with respect to the effort and risk choices of the portfolio manager. The manager's employment contract promises her: (a) a fixed payment, (b) a proportional asset-based fee, (c) a benchmark-linked fulcrum fee, and (d) 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.

Keywords: Incentive Contracts, Delegated Portfolio Management, Mutual Funds, Performance Fees

JEL Classification: G10, G20

Suggested Citation

Li, C. Wei and Tiwari, Ashish, Incentive Contracts in Delegated Portfolio Management (May 1, 2008). Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=972312

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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