Moral Hazard in Active Asset Management

39 Pages Posted: 30 Aug 2014 Last revised: 19 Nov 2016

David C. Brown

University of Arizona - Department of Finance

Shaun William Davies

University of Colorado at Boulder - Leeds School of Business

Date Written: September 14, 2016

Abstract

We consider a model of active asset management in which mutual fund managers exert unobservable effort to earn excess returns. Investors allocate capital to both actively managed funds and passively managed products (e.g., index funds or ETFs). In the model's equilibrium, investors are indifferent between investing an additional dollar with an active manager or with a passively managed product. As passively managed products become more attractive to investors, active managers' revenues from portfolio-management services fall, reducing their effort incentives. The analysis relates recent trends in management fees and holdings-based measures of moral hazard. Furthermore, we provide novel empirical predictions.

Keywords: Active Management, Closet Indexing, Mutual Funds, Performance Fees, Index Funds, ETFs, Moral Hazard

JEL Classification: G10, G20

Suggested Citation

Brown, David C. and Davies, Shaun William, Moral Hazard in Active Asset Management (September 14, 2016). Paris December 2015 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2489113 or http://dx.doi.org/10.2139/ssrn.2489113

David C. Brown

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States
520-626-0746 (Phone)

HOME PAGE: http://www.davidclaytonbrown.com

Shaun William Davies (Contact Author)

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

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