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Moral Hazard and the Portfolio Management Problem
Author(s) -
STOUGHTON NEAL M.
Publication year - 1993
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1993.tb05140.x
Subject(s) - unobservable , moral hazard , portfolio , incentive , class (philosophy) , microeconomics , quadratic equation , actuarial science , project portfolio management , contract theory , information asymmetry , observable , business , economics , computer science , mathematical optimization , econometrics , mathematics , finance , project management , management , geometry , artificial intelligence , physics , quantum mechanics
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.