Portfolio Performance and Agency

32 Pages Posted: 13 Nov 2008

See all articles by Philip H. Dybvig

Philip H. Dybvig

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

Heber Farnsworth

Rice University

Jennifer N. Carpenter

New York University (NYU) - Department of Finance

Multiple version iconThere are 5 versions of this paper

Date Written: December 1999

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

Dybvig, Philip H. and Farnsworth, Heber and Carpenter, Jennifer N., Portfolio Performance and Agency (December 1999). NYU Working Paper No. S-AM-99-01, Available at SSRN: https://ssrn.com/abstract=1300788

Philip H. Dybvig (Contact Author)

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

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
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Heber Farnsworth

Rice University ( email )

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

Jennifer N. Carpenter

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

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0352 (Phone)
212-995-4233 (Fax)

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