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 a 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
To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.