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How nonlinear benchmark in delegation contract can affect asset price and price informativeness

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  • Jiliang Sheng

    (Jiangxi University of Finance and Economics)

  • Yanyan Yang

    (Jiangxi University of Finance and Economics)

  • Xiaoting Wang

    (Acadia University)

  • Jun Yang

    (Acadia University)

Abstract

Delegation contracts with conventional linear benchmarking cannot motivate institutions to acquire information, which deteriorates price informativeness and increases return volatility. This study investigates performance-based contracts in which the benchmark is a nonlinear (quadratic) function of the benchmark portfolio return. In a unified model incorporating both information acquisition and investment decisions, we show that delegation contracts with the nonlinear benchmark can overcome the weakness of conventional benchmarked contracts. Specifically, they can incentivize information acquisition, enhance price informativeness, lower return volatility, and, when penalty intensity is relatively low, increase institutions’ expected utility and reduce fixed delegation costs. The impact of the contract’s incentive component on the equilibrium price and price informativeness depends on the average incentive slope. Further analysis finds that delegated investment by informed institutional investors can improve price informativeness. This effect is more pronounced under nonlinear benchmarked contracts than under non-benchmarked or linear benchmarked contracts.

Suggested Citation

  • Jiliang Sheng & Yanyan Yang & Xiaoting Wang & Jun Yang, 2024. "How nonlinear benchmark in delegation contract can affect asset price and price informativeness," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 78(4), pages 1117-1168, December.
  • Handle: RePEc:spr:joecth:v:78:y:2024:i:4:d:10.1007_s00199-024-01573-w
    DOI: 10.1007/s00199-024-01573-w
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    More about this item

    Keywords

    Performance-based contract; Nonlinear benchmark; Information acquisition incentive; Price informativeness;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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