This study provides evidence that links institutional trading behavior directly to anomalous turn-of-the-year return patterns of small stocks. We find that turn-of-the-year trading patterns of institutions reflect strategies generally consistent with window-dressing and risk-shifting behaviors. Institutions sell more loser small stocks in the last quarter of the year, but buy more small stocks, winners and losers, in the first quarter. Institutional buying (selling) of loser stocks at year-end weakens (strengthens) the turn-of-the-year effect. Buying of winner stocks after year-end causes a statistically significant, though weaker, effect.

The literature suggests that while decentralized decision making can allow for greater specialization in an organization, it heightens the cost of coordinating decisions. The mutual fund industry—in particular, sole- and team-managed balanced funds—provides an ideal setting to test the specialization versus coordination trade-off, as information on decision structures and fund actions is easily obtained. We show that sole-managed balanced funds, with centralized decision rights, exhibit significant market timing that requires reallocation across asset classes. However, consistent with coordination difficulties between managers specializing in particular asset classes, no market timing is evident in team-managed balanced funds. Team-managed funds exhibit greater returns from specialization, in the form of better security selection performance than sole-managed funds. These results hold cross-sectionally and for funds that switch management structures. The overall returns across different management structures are similar, indicating a market equilibrium. Investor flows reward market-timing performance for sole- but not team-managed funds.

The U.S. money management industry is geographically concentrated and diverges from the geographic clustering of public firms. We find that firms located in states with strong institutional investor presence have high valuation. These firms invest more and their investments are less dependent on internal cash flow. They are more likely to issue equity than debt for financing needs, and local institutions hold more of the newly issued equity. The results show the geographic dislocation between institutional investors and firms contributes to financial market frictions, and a strong institutional investor presence alleviates the funding friction of local firms, leading to high valuation.