An optimal-incentive contract for managers with exponential utility

This paper examines the manager-investor relationship in the case of exponential utility when the manager of investments in real or financial assets has an endowment which can be invested in the risky assets for which he has private information. We obtain a relationship showing trade-offs or hedging behavior among the investments the manager can choose for himself and the principal. Even with the hedging ability of the manager, the well-known first-best solution with `no moral hazard' risk-sharing is obtained among these possible solutions to the manager's problem by specifying a `no conflict of interest', zero investment by the manager of his own endowment in those risky assets for which he has private information. Thus, the agent imputes no disutility to the assignment of the principal's investments and the investor is assured of an investment strategy that he would make if he had access to the manager's private information.