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http://hdl.handle.net/2451/26954
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| Title: | Optimal Compensation for Fund Managers of Uncertain Type: Informational
Advantages of Bonus Schemes |
| Authors: | Stremme, Alexander |
| Keywords: | Fund Manager Compensation
Portfolio Choice
Asymmetric Information
Learning by Experimentation |
| Issue Date: | Oct-1999 |
| Series/Report no.: | FIN-99-029 |
| Abstract: | Performance-sensitivity of compensation schemes for portfolio managers
is well explained by classic principal-agent theory as a device to
provide incentives for managers to exert effort or bear the cost of
acquiring information. However, the majority of compensation packages
observed in reality display in addition a fair amount of convexity in
the form of performance-related bonus schemes. While convex contracts
may be explained by principal-agent theory in some rather specific
situations, they have been criticized, both by the financial press as
well as the academic literature, on the grounds that they may lead to
excessive risk-taking. In this paper, we show that convex compensation
packages, though likely to be myopically not optimal, may serve as a
device to extract information about the ex-ante uncertain type of
portfolio managers. Optimal contracts are thus determined by the
trade-off between maximizing short-run expected returns on one hand, and
long-run informational benefits on the other. In a discrete-time model,
combining dynamic principal-agent theory with the theory of learning by
experimentation, we characterize optimal incentive schemes and optimal
retention rules for fund managers, consistent with empirical observations. |
| URI: | http://hdl.handle.net/2451/26954 |
| Appears in Collections: | Finance Working Papers
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