Falsification in Financial Advice

This work gives another fundamental explanation for the stylized fact of active management underperformance. I develop a model of delegated portfolio management with adverse selection, where the preferences of investor and advisor are misaligned. The information structure I focus on is intermediate between the cases of private and public information: the advisor can distort the observed sharpe ratio at some cost. I show that investor may strictly prefer the contract that induces falsification as it helps him to manipulate the information rents of the agent. Within the model I show that investor prefers to deal with the advisors that have higher partisan objective as it leads to higher expected utility. I study how optimal contract and welfare changes when the information structure changes from private to public. The relation between the social welfare and the degree of information publicness is non-monotonic: although social welfare is maximum under pure public information, increasing the publicness of information may decrease the welfare.