Theories of the effects of delegated portfolio managers' incentives

Delegated portfolio managers, such as hedge funds, mutual funds and pension funds, play a crucial role in financial markets. While it is well-known that their incentives are misaligned with those of their clients, the consequences of this misalignment are understudied. This thesis studies the effects of delegated portfolio managers' incentives in the real economy, in corporate governance and in portfolio allocation. In the first paper, 'Do institutional investors improve capital allocation?', I show that delegated portfolio managers' misalignment of incentives - which I model as their career-concerns - has real and positive economic effects. I find that delegated portfolio managers allocate capital more efficiently than other investors who do not face similar incentives; this promotes investment, fosters firms' growth, and enriches shareholders. In the second paper, 'The Wall Street walk when investors compete for flows"', Amil Dasgupta and I show a negative side of delegated portfolio managers' career concerns. When delegated portfolio managers hold blocks of shares in firms, the more they care about their careers, the less effectively their exit threats discipline firm managers. Our result generates testable implications across different classes of funds: only those funds who have relatively high-powered incentives will be effective in using exit as a governance mechanism. Finally, the third paper, 'Investment mandates and the downside of precise credit ratings', co-authored with Jason Roderick Donaldson, studies whether the misalignment of incentives between delegated portfolio managers and their investors are tempered with contracts based on precise credit ratings. Surprisingly, we find that while, at equilibrium, portfolio managers write contracts making reference to credit ratings, this is inefficient; in particular, as the rating's precision increases everyone is worse off