The principal-agent problem in fund management
- January 7th, 2013
Before diving head long into the new year I wanted to point out a a paper that came out last month. A paper by Paul Woolley and Dimitri Vayanos at the London School of Economics entitled “Taming the finance monster” attracted a fair bit of attention. In it they take to task the owners of capital for essentially putting up with the ongoing shenanigans of fund managers on their behalf. In addition to taking to task efficient markets they try to tackle the principal-agent problem in fund management.
This is surely an overlooked topic in finance. The separation of actual fund management from capital owners presents all sorts of issues. One could argue that market failures, broadly defined, occur because of the mismatch in incentives for the parties. Woolley and Vayanos write:
Agents have learnt that financial markets do not function like goods markets, and that the usual laws of competition do not apply under asymmetric information. Moral hazard, complexity and opacity all help them capture rents. They also benefit from mispricing, volatility and the proliferation of products. The costs and fees of intermediation go hand in hand with pricing inefficiencies in contributing to the erosion of the returns on savings.
As noted earlier the paper attracted a number of pieces in the UK. While their call to a return to long term, fundamental investing sounds good in theory there seems to be a fair amount of skepticism about the likely uptake of the author’s recommendation both for investors and regulators alike. In any event, the principal-agent issue in finance is overlooked one. The paper is worth a look if for no other reason to remind ourselves of it.
Items that mention the Woolley and Vayanos paper:
Market failure. (Buttonwood’s notebook)
Tackling the two-headed monster of efficient markets theory and the principal-agent problem. (FT Alphaville)
Time to stop the addiction to momentum trading. (FT)
Big is not always beautiful. (Economist)
Abnormal Returns is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small commission, yet you don't pay any extra. Thank you for your support.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Abnormal Returns has over its seven-year life become a fixture in the financial blogosphere. Over thousands of posts we have striven to bring the best of the financial blogosphere to readers. In that time the idea of a “forecast-free investment blog” remains as useful as it did six years ago. More »
- Tuesday links: reinventing the wheel
- Monday links: mushy rhetoric
- Sunday links: an enlightening event
- Top clicks this week on Abnormal Returns
- Saturday links: staying private longer
- Friday links: exercising your strengths
- Thursday links: understanding Wall Street
- 6 Essential Principles from Pragmatic Capitalism by Cullen Roche
- Wednesday links: the multiplier effect
- Tuesday links: knowledge alone