NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Delegated Asset Management, Investment Mandates, and Capital Immobility

Zhiguo He, Wei Xiong

NBER Working Paper No. 14574
Issued in December 2008
NBER Program(s):   AP   CF

This paper develops a model to explain the widely used investment mandates in the institutional asset management industry based on two insights: First, giving a manager more investment flexibility weakens the link between fund performance and his effort in the designated market, and thus increases agency cost. Second, the presence of outside assets with negatively skewed returns can further increase the agency cost if the manager is incentivized to pursue outside opportunities. These effects motivate narrow mandates and tight tracking error constraints to most fund managers except those with exceptional talents. Our model sheds light on capital immobility and market segmentation that are widely observed in financial markets, and highlights important effects of negatively skewed risk on institutional incentive structures.

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This paper was revised on May 11, 2012

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Document Object Identifier (DOI): 10.3386/w14574

Published: Journal of Financial Economics Volume 107, Issue 2, February 2013, Pages 239–258 Cover image Delegated asset management, investment mandates, and capital immobility ☆ Zhiguo Hea, b, E-mail the corresponding author, Wei Xiongc, b, Corresponding author contact information, E-mail the corresponding author

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