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Management compensation and market timing under portfolio constraints

Agarwal, Vikas; Gómez, Juan-Pedro; Priestley, Richard
Journal article, Peer reviewed
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URI
http://hdl.handle.net/11250/93744
Date
2012
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Original version
http://dx.doi.org/10.1016/j.jedc.2012.05.006
Abstract
This paper shows that portfolio constraints have important implications for manage-

ment compensation and performance evaluation. In particular, in the presence of portfolio

constraints, allowing for benchmarking can be bene cial. Benchmark design arises as an al-

ternative e¤ort inducement mechanism vis-a-vis relaxing portfolio constraints. Numerically,

we solve jointly for the manager s linear incentive fee and the optimal benchmark. The size of

the incentive fee and the risk adjustment in the benchmark composition are increasing in the

investor s risk tolerance and the manager s ability to acquire and process private information.
Description
This is the authors’ final, accepted and refereed manuscript to the article
Publisher
Elsevier
Journal
Journal of Economic Dynamics and Control

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