Optimal Contracts for ESG Investing

We use a continuous-time principal agent framework to construct an optimal contract for a manager of an ESG fund that caters to socially minded investors. The closed-form contract encompasses a flat salary, a management fee proportional to the fund’s size, and an incentive fee linked to the fund’s excess return. In addition to these three traditional components, we introduce two new elements that encapsulates the socially minded investors’ demand for ESG: a portion proportional to the portfolio’s ESG score, and an incentive tied to the portfolio’s ESG score relative to a benchmark ESG portfolio