Reputation entrenchment or risk minimization?

Abstract

PurposeOne of the agency conflicts between investors and managers in fund management is reflected by risk‐taking behaviors led by their different goals. The investors may stop their investments in risky assets before the end of the investment horizon to minimize risk, while the managers may do so to entrench their reputation so as to pursue better opportunities in the labor market. This study aims to consider a one principal‐one agent model to investigate this agency conflict.Design/methodology/approachThe paper derives optimal asset allocation strategies for both parties by extending the traditional dynamic mean‐variance model and considering possibilities of optimal early stopping. Doing so illustrates the principal‐agent conflict regarding risk‐taking behaviors and managerial investment myopia in fund management.Practical implicationsThis paper not only paves the way for further studies along this line, but also presents results useful for practitioners in the money management industry.FindingsAccording to the theoretical analysis and numerical simulations, the paper shows that potential early stop can make the agency conflict worsen, and it proposes a way to mitigate this agency problem.Originality/valueAs one of the exploratory studies in investigating agency conflict regarding risk‐taking behaviors in the literature, this study makes multiple contributions to the literature on fund management, asset allocation, portfolio optimization, and risk management.