Working Paper: CEPR ID: DP17772
Authors: Rahul Deb; Mallesh Pai; Maher Said
Abstract: We develop a dynamic adverse selection model where a career-concerned buy-side analyst advises a fund manager about investment decisions. The analyst's ability is privately known, as is any information she learns over time. The manager wants to elicit information to maximize fund performance while also identifying and retaining high-skill analysts. We characterize the optimal dynamic contract, show that it has several features supported by empirical evidence, and derive novel testable implications. The fund manager's optimal contract both maximizes the value of information and screens out low-skill analysts by incentivizing the analyst to always provide honest advice.
Keywords: Dynamic Mechanism Design
JEL Codes: D82; D83; D86; G11; G14; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal dynamic contract (D86) | Honest recommendations (Y30) |
| Honest recommendations (Y30) | Maximize fund performance (G23) |
| Contract design (K12) | Screen out low-skill analysts (J24) |
| Timing of recommendations (C41) | Analyst retention (G24) |
| Analyst performance (D79) | Fund manager's decision to retain or terminate analysts (M51) |
| Earlier recommendations (Y50) | Skilled analysts (C38) |