Delegated Learning and Contract Commonality in Asset Management

Abstract

In the presence of moral hazard and costly information acquisition, performance pay and benchmarking arise as part of the optimal contract between investors and fund managers. The commonality in compensation incentives across funds, however, gives rise to externalities that distort expected returns and price informativeness, which feed back into fund manager behavior and investors’ capital allocation to asset management. This commonality contributes to the inconsistency of widely-adopted measures of active manager skill. From a social perspective, it leads to an active management industry whose size and fees do not sufficiently comove with the underlying asset environment.

Keywords: Fund Manager Compensation, Benchmarking, Moral Hazard, Information Acquisition, Contract Externality