Contracts are the ‘life-blood’ of the global financial industry. They make the chains of intermediation in the financial services industry possible. They underwrite virtually every transaction that takes place in financial markets. And I don’t think it’s overstating things to say that without contracts binding parties together over time and space, the world of finance would simply grind to a halt.
Given this fact, you’d think that most institutional investors would spend a great amount of time and effort working to improve their contracting capabilities – that these Giants would look to contracts as a strategic management device that could add value over the long run. But... you’d be wrong.
It’s for this reason that Gordon Clark and I have spent the past year investigating the contracting process at public pension funds and sovereign funds. (Yeah, sounds fun, right?) And, as it turns out, we’ve just finished our second paper on the topic, “State and Local Pension Fund Governance and the Process of Contracting for Investment Services.” We also did a paper a few months back entitled, “The Geography of Contract in the Global Financial Services Industry.
Part of the reason we wrote these papers and launched this project was based on our perception that Investment Management Agreements seemed to advantage (at least in general) the asset managers over asset owners. (I wonder where we got that idea?) In many cases, contracts were framed as fee-for-service agreements that, once signed, contained very little in the way of leverage for the owners. And so we set about to help the Giants use these “boring contracts” as strategic instruments to better govern their long-term relationships with asset managers.
What we found is that most contracts in the investment business are ill suited for the job at hand (i.e., producing risk-adjusted rates of return). They are either overly burdensome (limiting the innovation required to generate returns) or they are overly permissive (removing the discipline that Giants can impose on their managers). And so these external contracts aren’t all that effective. As a result, many of the larger funds have been looking to employment contracts (and in-sourcing) as an alternative to trying to write effective service contracts with outsiders.
Anyway, any and all feedback on the papers is welcome. Download them here and here (for free).
