Portfolio Performance and Agency

31 Pages Posted: 11 Nov 2008

See all articles by Heber Farnsworth

Heber Farnsworth

Rice University

Philip H. Dybvig

Washington University in St. Louis - John M. Olin Business School

Jennifer N. Carpenter

New York University (NYU) - Department of Finance

Multiple version iconThere are 5 versions of this paper

Date Written: April 2000

Abstract

The evaluation and compensation of portfolio managers is an important problem for practitioners. Optimal compensation will induce managers to expend effort to generate information and to use it appropriately in an informed portfolio choice. Our general model points the way towards analysis of optimal performance evaluation and contracting in a rich model. Optimal contracting in the model includes an important role for portfolio restrictions that are more complex than the sharing rule. The agent's compensation gives the agent approximately to benchmark return plus an incentive fee equal to a portfolio measure that is approximately the excess of return above the benchmark. This measure is often used by practitioners but is simpler than the Jensen measure and other measures commonly recommended in the academic literature. In addition to the excess return above the fixed benchmark, the manager is given some additional incentive to take a position that deviates from the benchmark to remove an incentive to tend towards being a "closet indexer." Efficient contracting involves restrictions on what portfolio strategies can be pursued, and prior communication of the information gathered.

Suggested Citation

Farnsworth, Heber and Dybvig, Philip H. and Carpenter, Jennifer N., Portfolio Performance and Agency (April 2000). NYU Working Paper No. FIN-99-046, Available at SSRN: https://ssrn.com/abstract=1298263

Heber Farnsworth (Contact Author)

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

Philip H. Dybvig

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Jennifer N. Carpenter

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0352 (Phone)
212-995-4233 (Fax)