Question
explain what's the difference between the two answers and lesson the question taught original question:The manager of your company's pension fund is compensated based entirely
explain what's the difference between the two answers and lesson the question taught
original question:The manager of your company's pension fund is compensated based entirely on fund performance; he earned over $1.2 million last year. As a result, the fund is contemplating a proposal to cap the compensation of fund managers at $100,000. Provide an argument against the proposal.
Textbook answer: The fund manager might be talented. and would feel that being proportionally compensated for it is appropriate. If all of a sudden he could only make $100,000 while making millions or billions for his clients, he would feel very undervalued and leave. Other funds would poach him away.
(I mention that the manager might be talented. Just because the fund make money doesn't mean he/she knew what he was doing. They can always gamble. There's an asymmetric bias. They can gamble with their clients money. If the client gains, they gain but if the clients lose, the manager does NOT lose.) There's incentive to gamble. That's why the pay for performance scheme in this situation may be problematic, it encourages excessive risk taking. There have been proposed schemes that can help alleviate this problem, one of them is for the manager to be compensated 5 years later. That way if the manager had taken a risk that would only temporarily boost profits but could hurt the firm in the long run, the clients/shareholders should be able to see that in 5 years and not improperly reward the manager.)
Second answer: The manager will have less of an incentive to manage the fund since capping his compensation to $100,000. The fund is highly unlikely to perform as well as it would have without the cap, although the funds may be managed adequately.
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