University of California, Irvine. This paper was presented to seminar audiences at UCLA, U.C. Riverside, and the Western Finance Association. I would like to acknowledge helpful comments by Jeff Coles, an anonymous referee, and especially Masako Darrough. This research was partially supported by a U.C. Irvine faculty fellowship.
Moral Hazard and the Portfolio Management Problem
Article first published online: 30 APR 2012
1993 The American Finance Association
The Journal of Finance
Volume 48, Issue 5, pages 2009–2028, December 1993
How to Cite
STOUGHTON, N. M. (1993), Moral Hazard and the Portfolio Management Problem. The Journal of Finance, 48: 2009–2028. doi: 10.1111/j.1540-6261.1993.tb05140.x
- Issue published online: 30 APR 2012
- Article first published online: 30 APR 2012
This paper investigates the significance of nonlinear contracts on the incentive for portfolio managers to collect information. In addition, the manager must be motivated to disclose this information truthfully. We analyze three contracting regimes: (1) first-best where effort is observable, (2) linear with unobservable effort, and (3) the optimal contract within the Bhattacharya-Pfleiderer quadratic class. We find that the linear contract leads to a serious lack of effort expenditure by the manager. This underinvestment problem can be successfully overcome through the use of quadratic contracts. These contracts are shown to be asymptotically optimal for very risk-tolerant principals.