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Optimal Contracts for Teams of Money Managers

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  • Pegaret Pichler
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    Abstract

    The optimal organizational form and optimal incentive contract are characterized for a team of money managers, assuming that the investor (principal) is risk averse and that each manager's (agent's) actions affect both that manager's expected return and the correlation of returns between managers. If the managers are risk tolerant, then a noncooperative team organization and a strictly competitive contract, in which each manager is rewarded both for doing well and for doing better than the team, is the most efficient way to discourage herding within the team. This is despite the fact that, in such a contract total wages paid are a concave function of total returns, and so using the contract to discourage herding (and thus achieve lower risk) is in direct conflict with the investor's objective of using the contract to transfer risk onto the managers. As the risk aversion of both the investor and the managers increases, cooperation among managers becomes the optimal way to organize the team. For some parameter values, if everyone is risk averse, first-best can be achieved under cooperation. First-best without herding can never be achieved if the managers are risk tolerant, or if cooperation is infeasible

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    Bibliographic Info

    Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 495.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:nawm04:495

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    Keywords: contracts for teams; money managers;

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