How nonlinear benchmark in delegation contract can affect asset price and price informativeness

Delegation contracts with conventional linear benchmarking cannot motivate institutions to acquire information, which deteriorates price informativeness and increases return volatility. This study investigates performance-based contracts in which the benchmark is a nonlinear (quadratic) function of the benchmark portfolio return. In a unified model incorporating both information acquisition and investment decisions, we show that delegation contracts with the nonlinear benchmark can overcome the weakness of conventional benchmarked contracts. Specifically, they can incentivize information acquisition, enhance price informativeness, lower return volatility, and, when penalty intensity is relatively low, increase institutions’ expected utility and reduce fixed delegation costs. The impact of the contract’s incentive component on the equilibrium price and price informativeness depends on the average incentive slope. Further analysis finds that delegated investment by informed institutional investors can improve price informativeness. This effect is more pronounced under nonlinear benchmarked contracts than under non-benchmarked or linear benchmarked contracts.