Delegated Learning and Contract Commonality in Asset Management

79 Pages Posted: 1 Jan 2017 Last revised: 19 Mar 2023

See all articles by Michael Sockin

Michael Sockin

University of Texas at Austin - Red McCombs School of Business

Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance

Date Written: January 1, 2017

Abstract

We examine the pecuniary externalities that arise when active fund manager compensation contracts have common components. This commonality in the compensation structure and loadings on each component across funds reduces asset price informativeness, amplifies the distortions from active managers’ benchmark-hedging demand, and lowers the price of risk in financial markets. This is because contract commonality distorts investors’ capital allocation to active management, and active managers’ information acquisition and trading decisions. From a normative perspective, contract commonality increases the rigidity of the active industry size and performance-based fee. As a result, they do not vary enough with financial market conditions compared to a Planner’s economy. Quantitatively, an increase in asset payoff uncertainty increases the size and performance-based fee twice as much in the Planner economy compared to the decentralized economy. From a positive perspective, contract commonality contributes to the inconsistency of several widely adopted measures of active manager skill.

Keywords: Fund Manager Compensation, Benchmarking, Moral Hazard, Information Acquisition, Contract Externality

Suggested Citation

Sockin, Michael and Xiaolan, Mindy Z., Delegated Learning and Contract Commonality in Asset Management (January 1, 2017). Available at SSRN: https://ssrn.com/abstract=2891616 or http://dx.doi.org/10.2139/ssrn.2891616

Michael Sockin (Contact Author)

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

HOME PAGE: http://sites.google.com/view/mindyxiaolan

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