Institutionalization, Delegation, and Asset Prices

Abstract

We investigate the e§ects of institutionalization on fund manager compensation and asset prices. Institutionalization raises the performance-sensitive part of the equilibrium contract, making institutional investors e§ectively more risk averse. In consequence, institutionalization has two opposing e§ects on market outcomes. The direct e§ect is to bring in more informed institutional investors, and the indirect e§ect is to make each institutional investor trade less aggressively on information. Institutionalization can non-monotonically a§ect the cost of capital and return volatility. Releasing public information has similar e§ects as institutionalization. Our theory helps to understand a wide range of Önancial phenomena and suggests new testable predictions.