Incentive Contract in Delegated Portfolio Management Under VaR Constraint

Linear contracts are popular in delegated portfolio management. This paper studies the incentive of linear performance-adjusted contracts in delegated portfolio management under a VaR constraint with a principal-agent model and numerical analysis. It is shown that a linear performance-based contract provides incentives to a portfolio manager to work at acquiring private information under a total risk constraint. The expected utility and optimal effort are increasing functions of the return sharing ratio for a risk-averse manager. However, a risk constraint makes a portfolio manager to reduce effort in gathering private information, suggesting that the VaR constraint increases the moral hazard between the investor and the manager.