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Typically, investors delegate the management of their investments to asset managers, which creates a layer of asymmetric information which is not treated in the standard portfolio theory. Investors are represented by the board that is responsible for sub-contracting with the managers. Ideally, the contractual features should have the following three characteristics. First, it should attract the best managers. Second, it should incentivize managers to generate outperformance even after the contract is signed. Finally, it should lead to an optimal risk sharing between the investors and the asset manager.
As highlighted by Agarwal et al. (2009) the typical contracting features of HF’s provide a good environment to test the role of managerial incentives. The corporate finance...
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