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The standard approach to portfolio theory presumes that individuals, given their risk aversion, select their own portfolios. In general, however, this is not the case as most of the investments are delegated to Asset Managers. This added layer is a potential source of frictions due to the asymmetry of information between the asset manager and the investor. From a micro-economic viewpoint this is modelled as a Principal-Agent relationship. The Principal, the investor, aims to make sure that the Agent, the manager, spends effort and takes the decisions that make the Principal well off. Formally, the Principal has to design a contract as well as compensation features that lead to the following outcomes.
First, the best managers are selected and they want to work for the...
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