Skip Navigation


RFS Advance Access originally published online on March 25, 2009
Review of Financial Studies 2009 22(11):4681-4714; doi:10.1093/rfs/hhp013
This Article
Right arrow Full Text
Right arrow Full Text (PDF)
Right arrow All Versions of this Article:
22/11/4681    most recent
hhp013v1
Right arrow Alert me when this article is cited
Right arrow Alert me if a correction is posted
Services
Right arrow Email this article to a friend
Right arrow Similar articles in this journal
Right arrow Alert me to new issues of the journal
Right arrow Add to My Personal Archive
Right arrow Download to citation manager
Right arrowRequest Permissions
Google Scholar
Right arrow Articles by Li, C. W.
Right arrow Articles by Tiwari, A.
Social Bookmarking
Add to CiteULike   Add to Connotea   Add to Del.icio.us  
What's this?

© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.

Incentive Contracts in Delegated Portfolio Management

C. Wei Li
Ourso College of Business Administration, Louisiana State University

Ashish Tiwari
Henry B. Tippie College of Business, University of Iowa

Send correspondence to C. Wei Li, Department of Finance, Ourso College of Business Administration, Louisiana State University, Baton Rouge, LA 70803-1000, telephone: 225-578-6260, fax: 225-578-6366. E-mail: wli{at}lsu.edu.

JEL Classification: G11, G12, D82, D86


  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.

We thank two anonymous referees, David Musto (WFA discussant), Raman Uppal (the editor), Paul Weller, and seminar participants at Louisiana State University for their helpful comments.


Add to CiteULike CiteULike   Add to Connotea Connotea   Add to Del.icio.us Del.icio.us    What's this?




Disclaimer: Please note that abstracts for content published before 1996 were created through digital scanning and may therefore not exactly replicate the text of the original print issues. All efforts have been made to ensure accuracy, but the Publisher will not be held responsible for any remaining inaccuracies. If you require any further clarification, please contact our Customer Services Department.