Portfolio Performance on Agency Mechanism with Capability of Manager

Abstract

By given different capabilities of managers, a novel model of optimal contracting is proposed in agency problems, which adds a new variable denoted by the manager’s ability in delegated portfolio management. Then we compare our results with Dybvig and Farnsworth’s (2010) and find a new effect by appending this variable. The results show that in the first-best situation with log utility, the optimal contract is in accord with the result of Dybvig and Farnsworth’s (2010). In the second-best situation, the optimal contract is a proportional sharing rule plus a bonus. However, the bonus is associated with variables including private signals and the manager’s ability. In the third-best situation, the manager’s share is no longer a constant; and the manager’s fee is no longer a linear combination of the returns, which depends on the signal and the manager’s ability. So manager’s ability is an important variable for the market return. We can also find that these institutional features are more similar to practice than other existing agency models and consistent with the reality of the situation. The numerical results also verify the solutions.