What economic forces limit mutual fund managers from generating consistent outperformance? We propose and test the hypothesis that buy-side competition from other funds matters. We make three contributions. First, we propose new style-based spatial methods to identify the customized rivals of each fund. Second, we construct dynamic, fundspecific measures of competition and generate measures of skill as a fund’s outperformance relative to its customized peers. Third, and finally, we show that funds outperforming their customized rivals generate future alpha when they face less competition. These results are economically significant and last for over four quarters.

We examine the joint optimization of financial leverage and irreversible capacity investment in a real options framework with risky debt and endogenous interest costs. Higher capacity, ceteris paribus, increases operating leverage and default probability, but lowers ex post adjustment costs and generates larger tax shields. A key insight is that financial leverage and capacity are substitutes in the debt market equilibrium. We develop novel predictions about the effects of capital adjustment costs, operating costs, and uncertainty on optimal financial leverage and capacity that may potentially help explain ambiguous empirical results in the literature regarding the determinants of capital structure and investment. Received March 17, 2016; editorial decision July 8, 2017 by Editor Itay Goldstein.

What economic forces limit mutual fund managers from generating consistent outperformance? We propose and test the hypothesis that buy-side competition from other funds matters. We make three contributions. First, we propose new style-based spatial methods to identify the customized rivals of each fund. Second, we construct dynamic, fund-specific measures of competition and generate measures of skill as a fund’s outperformance relative to its customized peers. Third, and finally, we show that funds outperforming their customized rivals generate future alpha when they face less competition. These results are economically significant and last for over four quarters. Received September 11, 2016; editorial decision September 26, 2017 by Editor Itay Goldstein.