Abstract
I build a model of delegated asset management with moral hazard and security lending. Lending markets transfer informational rents from short-sellers to funds. Investors optimally receive the proceeds as state-contingent dividends which correlate with shorting demand, providing a natural hedge. Fee discounts are optimal only if funds can appropriate lending revenues, for example through affiliated lending agents. Lower fund costs may lead to a zero-fee trap, where funds charge no management fees but fully extract lending income. In equilibrium, funds holding riskier underlying portfolios are more transparent, pay higher dividends, and charge higher management fees than funds with safer investments.
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