Dynamic Contracting in Asset Management Under the Investor-Partner-Manager Relationship

We study incentive contracts in asset management business under dynamic actions and relationships between an investor, a partner of an investment company, and a fund manager of the company. Both the manager and the partner exert costly effort to manage the investments. The investor cannot perfectly observe the partner’s and manager’s actions, and similarly, the partner cannot perfectly observe the manager’s actions. Thus, we consider a hierarchical contracting framework under hidden efforts, where the investor contracts with the partner and the partner contracts with the manager. We show how the actions of the participants and the costs of their actions interact. For instance, the optimal effort of the manager falls in the effort cost of the partner. We extend the model to a case with an investor, a partner, and multiple managers. In this case, each manager’s effort rises in the effectiveness of the managers’ cooperation and falls in the other managers’ effort cost.