I examine the effect of prudent-man laws on the behavior of institutional investors. Variation in exposure to legal liability across types of investment managers allows me to disentangle the effect of the prudent-man laws from other potential influences on manager behavior. Bank managers significantly tilt the composition of their portfolios toward stocks that are viewed by the courts as prudent, while mutual fund managers choose not. I show that differences in the direction that bank and mutual fund managers choose to tilt may explain their portfolio performance differences over time.

We apply an event-study methodology on over 10,000 Morningstar star rating changes and find that Morningstar has subsantial independent influence on the investment allocation decisions of retail mutual fund investors. It is the discrete change in the star rating itself and not the change in the underlying performance measures that drives frow. We document econnomically and statistically significant positive abnormal flow following rating upgrades, and negative abnormal flow following rating downgrades. In contrast to the cross-sectional flow performance literature, we find evidence of investor punishment of performance declines, some of which is evident immediately in the month of the rating change.

Diane Del Guercio, Paula A. Tkac, The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension Funds, The Journal of Financial and Quantitative Analysis, Vol. 37, No. 4 (Dec., 2002), pp. 523-557

Union and public pension funds, the most prolific institutional activists employing low-cost targeting methods, are often accused of pursuing private benefits. Extant literature finds that unions representing workers, as stakeholders, are not aligned with shareholders. Limiting shareholder power may mitigate “special interest” activism but can also exacerbate managerial agency problems. In two different settings, majority approved and withdrawn shareholder proposals, we examine and find supportive evidence that the director labor market as a corporate governance mechanism can selectively mitigate the negative influence that conflicted stakeholder-shareholder union funds have over firms without stifling all influence of low-cost activists.

We analyze whether board structure and director independence in closed-end investment companies are related to shareholder interests in ways that are consistent with boards being effective monitors. We report that funds with relatively low expense ratios, one measure of board effectiveness, have smaller boards, a higher proportion of board members who are legally considered independent, relatively low director compensation, and charter provisions that specify remedial action if discounts become large. Evidence from our analysis of major fund restructuring decisions, including share repurchases, open-ending proposals and right offerings, is largely consistent with the expense ratio analysis. Overall, board characteristics that we identify with effective board independence are associated with lower expense ratios and value-enhancing restructurings.

To rationalize the well‐known underperformance of the average actively managed mutual fund, we exploit the fact that retail funds in different market segments compete for different types of investors. Within the segment of funds marketed directly to retail investors, we show that flows chase risk‐adjusted returns, and that funds respond by investing more in active management. Importantly, within this direct‐sold segment, we find no evidence that actively managed funds underperform index funds. In contrast, we show that actively managed funds sold through brokers face a weaker incentive to generate alpha and significantly underperform index funds.

We examine the performance of mutual funds whose managers simultaneously manage portfolios with performance-based incentive fees for three account types: mutual funds, hedge funds, and separate accounts. Importantly, our data set is free of selection bias because it is hand-collected from mandatory SEC filings. We find that only funds whose managers also manage hedge funds significantly underperform peer mutual funds. Moreover, underperformance begins only after fund managers begin to manage a hedge fund. We find that managerial incentives and opportunities for cross-subsidization explain variation in underperformance across funds, supporting the conflicts of interest hypothesis in the debate on “side-by-side management.”