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Gaming Performance Fees by Portfolio Managers

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  • Dean P. Foster

    (Wharton School, University of Pennsylvania.)

  • H. Peyton Young

    (University of Oxford and The Brookings Institution)

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    Abstract

    We show that it is very difficult to devise performance-based compensation contracts that reward portfolio managers who generate excess returns while screening out managers who cannot generate such returns. Theoretical bounds are derived on the amount of fee manipulation that is possible under various performance contracts. We show that recent proposals to reform compensation practices, such as postponing bonuses and instituting clawback provisions, will not eliminate opportunities to game the system unless accompanied by transparency in managers' positions and strategies. Indeed, there exists no compensation mechanism that separates skilled from unskilled managers solely on the basis of their returns histories. (c) 2010 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..

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    Bibliographic Info

    Article provided by MIT Press in its journal Quarterly Journal of Economics.

    Volume (Year): 125 (2010)
    Issue (Month): 4 (November)
    Pages: 1435-1458

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    Handle: RePEc:tpr:qjecon:v:125:y:2010:i:4:p:1435-1458

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    Cited by:
    1. Dean Foster & Rakesh Vohra, 2011. "Calibration: Respice, Adspice, Prospice," Discussion Papers 1537, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. John Thanassoulis, 2012. "Bank Pay Caps, Bank Risk, and Macroprudential Regulation," Economics Series Working Papers 636, University of Oxford, Department of Economics.
    3. Miller, Marcus & Zhang, lei, 2013. "The Invisible Hand and the Banking Trade: Seigniorage, Risk-shifting and More," CAGE Online Working Paper Series 135, Competitive Advantage in the Global Economy (CAGE).
    4. repec:cge:warwcg:134 is not listed on IDEAS
    5. Peter Sinclair, 2011. "Deficits, Debts and Defaults - Past, Present and Future," Discussion Papers 11-20, Department of Economics, University of Birmingham.

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