One of the most important financial professionals, e.g. wealth managers, asset managers, fund managers, is to reduce information asymmetry when they make/recommend capital allocation decision for asset owners who lend capital to creditors. Rent seeking behavior – or principal-agent problem could well take place when the financial professional understates the risks – particularly if purposefully – or over-promises returns to the asset owner.
Such behavior is more likely to happen than otherwise if:
- The financial compensation of the financial professional depends on the size/success of the transaction, rather than the realized return of the underlying asset; and
- the reputation risk is low, if the professional can easily change his job when things get ugly; and
- the asset owner has yet to adapt to a lower level of expected return, when the economy slows down and assets fail to generate the same level of return as before.
Unfortunately, this behavior happens in many parts of the world currently (including China) where economy is slowing down, asset quality is deteriorating and yet more and more money flow into the financial market – on the back of central bank easing – chasing fewer productive assets.