Motivating and Compensating Investment Advisors
This paper considers the problem of how an investor can optimally motivate an investment advisor to exert costly effort to gather valuable investment information. We show that compensation schemes that are increasing in the investment payoffs may fail to optimally motivate the advisor. We then characterize the conditions under which the private nature of the advisor's acquired information affects how he is optimally motivated to work diligently and present the resulting optimal compensation. We establish the conditional optimality of benchmark-indexed compensation and provide an explanation to the limited use of such compensation schemes in practice.