Is ‘Voting with Your Feet’ an Effective Mutual Fund Governance Mechanism?
46 Pages Posted: 5 Dec 2010
Date Written: July 30, 2010
Abstract
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 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 the scandals. These findings suggest that investors’ 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.
Keywords: investor vigilance, flow sensitivity, trading practice, market discipline
JEL Classification: G23, G28
Suggested Citation: Suggested Citation
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