Working Paper: NBER ID: w14574
Abstract: This paper develops a model to explain the widely used investment mandates in the institutional asset management industry based on two insights: First, giving a manager more investment flexibility weakens the link between fund performance and his effort in the designated market, and thus increases agency cost. Second, the presence of outside assets with negatively skewed returns can further increase the agency cost if the manager is incentivized to pursue outside opportunities. These effects motivate narrow mandates and tight tracking error constraints to most fund managers except those with exceptional talents. Our model sheds light on capital immobility and market segmentation that are widely observed in financial markets, and highlights important effects of negatively skewed risk on institutional incentive structures.
Keywords: Delegated Asset Management; Investment Mandates; Capital Immobility
JEL Codes: G01; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| providing fund managers with more investment flexibility (G23) | increases agency costs (G34) |
| presence of outside assets with negatively skewed returns (G19) | increases agency costs (G34) |
| increased agency costs (G34) | motivates narrow mandates (D72) |
| tighter tracking error constraints (C51) | mitigates agency costs (G34) |
| increased agency costs (G34) | leads to capital immobility in financial markets (F21) |