Effective Measures to Improve Alignment in Manager Fees; Moral Hazard Can Be Decreased

Abstract

In an ideal world asset managers would be perfectly aligned with their investors via an optimal incentive contract. In the current crisis this does not seem the case, so it is worthwhile to investigate how this can be improved upon. In the theory of delegated management this optimal (incentive) fee is often a linear fee, under several often stringent assumptions. In practice we see that a lot of the incentive contracts are convex sharing rules with option characteristics. This could (and does) typically introduce moral hazards on the side of the manager. We will show the working of a number of fee contracts in practice. Furthermore, we will propose several improvements on the standard convex fee contracts to make them more aligned with the investors. In effect these suggested improvements makes practical fee arrangements more linear.