Moral hazard and the dynamic delegated asset management

Abstract I study a dynamic relationship between an investor and a fund manager who in each period receives a fee proportional to the assets under management (AUM) as his compensation. The target is to study the efficiency of the long-run relationship in inducing the fund manager to expend effort. Efficiency is measured by comparing the dynamic model to a one-period benchmark model where the manager’s effort is observable (first best). I show under certain conditions, the first best is attained if the manager can decide on the management fee rate each period after (not before) observing the size of assets under management. This can be implemented by specifying in the manager’s compensation contract an AUM-dependent fee rate schedule rather than a fixed fee rate.