Do Portfolio Manager Contracts Contract Portfolio Management?

Abstract

Most mutual fund managers have performance-based contracts. Our theory predicts that mutual fund managers with asymmetric contracts and mid-year performance close to their announced benchmark increase their portfolio risk in the second part of the year. As predicted by our theory, performance deviation from the benchmark decreases risk-shifting only for managers with performance contracts. Deviation from the benchmark dominates incentives from the flow-performance relation, suggesting that risk-shifting is motivated more by management contracts than by a tournament to capture flows.