Investors in open-end mutual funds can vote with their feet by withdrawing assets from or adding assets to these funds. This paper assesses the effectiveness of this market discipline mechanism by investigating whether voting with the feet prevents the abusive practices that led to the 2003–2004 trading scandals. The research results indicate that funds with higher flow sensitivity—that is, a higher density of vigilant clients—have lower arbitrage potential and fewer abnormal flows, which in turn implies less opportunistic trading. As a result, these funds have a lower probability of being implicated in scandals. These findings suggest that investor ability to withdraw assets from or add assets to the funds is an effective mutual fund governance mechanism. In funds with less sophisticated investors who cannot use this option, other means of governance are especially important.

Staleness in measured prices imparts a positive statistical bias and a negative dilution effect on mutual fund performance. First, evaluating performance with nonsynchronous data generates a spurious component of alpha. Second, stale prices create arbitrage opportunities for high-frequency traders whose trades dilute the portfolio returns and hence fund performance. This paper introduces a model that evaluates fund performance while controlling directly for these biases. Empirical tests of the model show that alpha net of these biases is on average positive although not significant and about 40 basis points higher than alpha measured without controlling for the impacts of stale pricing. The difference between the net alpha and the measured alpha consists of 3 components: a statistical bias, the dilution effect of long-term fund flows, and the dilution effect of arbitrage flows. Whereas the former 2 components are small, the latter is large and widespread in the fund industry.