[We develop a simple model of the price impact of institutional herding. The empirical literature indicates that institutional herding positively predicts short-term returns but negatively predicts long-term returns. We offer a theoretical resolution to this dichotomy. In our model, career-concerned money managers trade with security dealers endowed with market power and exhibit an endogenous tendency to imitate past trades. This tendency is exploited by dealers and thus affects prices. In equilibrium, institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our article also generates several new, testable predictions that link institutional herding with the time-series properties of returns and volume.]

We develop a dual-layered agency model to study blockholder monitoring by activist funds competing for investor flow. Competition for flow affects the manner in which activist funds govern as blockholders. In particular, funds inflate their short-term performance by increasing payouts that are financed by higher (net) leverage. Doing so subsequently discourages value-creating interventions during economic downturns because of debt overhang. Our theory suggests a new channel via which asset manager incentives may foster economic fragility and links together the observed procyclicality of activist investments with the documented effect of such funds on the leverage of their target companies. (JEL G34, G23) Received July 2, 2020; editorial decision August 8, 2020; Editor Uday Rajan.

ABSTRACT Effective monitoring by equity blockholders is important for good corporate governance. A prominent theoretical literature argues that the threat of block sale (“exit”) can be an effective governance mechanism. Many blockholders are money managers. We show that, when money managers compete for investor capital, the threat of exit loses credibility, weakening its governance role. Money managers with more skin in the game will govern more successfully using exit. Allowing funds to engage in activist measures (“voice”) does not alter our qualitative results. Our results link widely prevalent incentives in the ever‐expanding money management industry to the nature of corporate governance.

We develop a simple model of the price impact of institutional herding. The empirical literature indicates that institutional herding positively predicts short-term returns but negatively predicts long-term returns. We offer a theoretical resolution to this dichotomy. In our model, career-concerned money managers trade with security dealers endowed with market power and exhibit an endogenous tendency to imitate past trades. This tendency is exploited by dealers and thus affects prices. In equilibrium, institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our article also generates several new, testable predictions that link institutional herding with the time-series properties of returns and volume.

ABSTRACT Recent studies show that single‐quarter institutional herding positively predicts short‐term returns. Motivated by the theoretical herding literature, which emphasizes endogenous persistence in decisions over time, we estimate the effect of multiquarter institutional buying and selling on stock returns. Using both regression and portfolio tests, we find that persistent institutional trading negatively predicts long‐term returns: persistently sold stocks outperform persistently bought stocks at long horizons. The negative association between returns and institutional trade persistence is not subsumed by past returns or other stock characteristics, is concentrated among smaller stocks, and is stronger for stocks with higher institutional ownership.

The growth of the asset management industry has made it commonplace for firms to have multiple institutional blockholders. In such firms, the strength of governance via exit depends on how blockholders react to each other’s exit. We present a model to show that open-ended institutional investors such as mutual funds react strongly to an informed blockholder’s exit, leading to correlated exits that enhance corporate governance. Our analysis points to a new role for mutual funds in corporate governance. We examine the trades of mutual funds around exits by activist hedge funds to present empirical evidence consistent with our model.

Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signalling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there is no large investor, small investors attack the currency when fundamentals are stronger. Yet, the difference can be small, or non-existent, depending on the relative precision of private information of the small and large investors. Adding signalling makes the influence of the large trader on small traders' behaviour much stronger. Copyright 2004, Wiley-Blackwell.

ABSTRACT We investigate whether business ties with portfolio firms influence mutual funds' proxy voting using a comprehensive data set spanning 2003 to 2011. In contrast to prior literature, we find that business ties significantly influence promanagement voting at the level of individual pairs of fund families and firms after controlling for Institutional Shareholder Services (ISS) recommendations and holdings. The association is significant only for shareholder‐sponsored proposals and stronger for those that pass or fail by relatively narrow margins. Our findings are consistent with a demand‐driven model of biased voting in which company managers use existing business ties with funds to influence how they vote.