One of the biggest conflicts that can arise within a family office is that between the family or families that own the wealth (the principals) and the fund managers and external providers (the agents).
The Credit Suisse Family Business Survey indicates that family businesses are not new to such conflicts between principals and agents, with families typically encountering problems as their business develops. But concerns about tension between principals and agents in family offices bring with them issues that are unique to delegated asset management.
A feature of this potential conflict is that principals and agents face different utility curves with respect to investment results. Most wealth owners face a diminishing marginal utility curve, which means that they value the next dollar slightly less than the one they already have. This is why investors typically derive more pain from
losing money on an investment than joy from making a profit.
But fund managers will tend to take more risks in their portfolios in order to beat benchmarks. This is because managers have more to gain from outperforming a rising market (through asset gathering) than they have to lose from underperformance in a declining market, since there are far fewer inflows. This mismatch of expectations means that wealth owners setting up family offices may face agency costs, and should set up appropriate monitoring and compensation mechanisms
to mitigate agency problems.
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