Management Compensation and Market Timing under Portfolio Constraints
41 Pages Posted: 25 Mar 2008 Last revised: 17 Mar 2015
Date Written: October 14, 2012
This paper shows that portfolio constraints have important implications for management compensation and performance evaluation. In particular, in the presence of portfolio constraints, allowing for benchmarking can be beneficial. Benchmark design arises as an alternative effort inducement mechanism vis-a-vis relaxing portfolio constraints. Numerically, we solve jointly for the manager's linear incentive fee and the optimal benchmark. The size of the incentive fee and the risk adjustment in the benchmark composition are increasing in the investor's risk tolerance and the manager's ability to acquire and process private information.
Keywords: Market Timing, Incentive Fee, Benchmarking, Portfolio Constraints
JEL Classification: D81, D82, J33
Suggested Citation: Suggested Citation