Investor Heterogeneity and Market Discipline: Evidence from Mutual Fund Adviser Misconduct

Abstract

Does investor heterogeneity affect the power of market discipline in mutual fund adviser misconduct? We show a significant difference in flow sensitivity to misconduct disclosures between institutional and retail investors. Market discipline is particularly weak among retail investors with limited attention. The effectiveness of discipline by investors in fact predicts misconduct likelihood. Investors' differential ability to impose market discipline also affects fund management profitability and turnover along with subsequent fund performance. Overall, our study highlights the real effects of investor heterogeneity on market discipline and casts doubt on the safety of retail investments under the current regulatory and market environment.

Keywords: Mutual Funds, Market Discipline, Corporate Governance, Investor Behavior

JEL Classification: G14, G23, G41