Moral hazard in active asset management

David C. Brown and Shaun William Davies

Journal of Financial Economics, 2017, vol. 125, issue 2, 311-325

Abstract: We consider a model of active asset management in which mutual fund managers exert unobservable effort to earn excess returns. Investors allocate capital to actively managed funds and passively managed products. In equilibrium, investors are indifferent between investing an additional dollar with an active manager or with a passively managed product. As passively managed products become more attractive to investors, active managers’ revenues from portfolio-management services fall, reducing their effort incentives. More-severe decreasing-returns-to-scale are also associated with reduced incentives and increased moral hazard. Performance-based fees and holdings-based data are all unlikely to mitigate moral hazard.

Keywords: Mutual funds; Moral hazard; Active management; Passive management (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:125:y:2017:i:2:p:311-325

DOI: 10.1016/j.jfineco.2017.05.010

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