Date Added: Dec 2009
Standard models of moral hazard predict a negative relationship between risk and incentives; however empirical studies on mutual funds present mixed results. In this paper, the authors propose a behavioral principal-agent model in the context of professional managers, focusing on active and passive investment strategies. Using this general framework, they evaluate how incentives affect the risk taking behavior of managers, using the standard moral hazard model as a special case; and solve the previous contradiction. Empirical evidence, based on a comprehensive world sample of 4584 mutual funds, gives support to the theoretical model.