Market Discipline and Internal Governance in the Mutual Fund Industry

University of Vienna, Department of Finance Working Paper No. 2004-3

AFA 2006 Boston Meetings Paper

39 Pages Posted: 7 Feb 2005  

Thomas Dangl

Vienna University of Technology

Youchang Wu

University of Oregon

Josef Zechner

Vienna University of Economics and Business

Multiple version iconThere are 3 versions of this paper

Date Written: February 2005

Abstract

We develop a continuous-time model in which a portfolio manager is hired by a management company. Based on observed portfolio returns, all agents update their beliefs about the manager's skills. In response, investors can move capital into or out of the mutual fund and the management company can fire the manager. Introducing firing rationalizes several empirically documented findings, such as the positive relation between manager tenure and fund size or the increase of portfolio risk before a manager replacement and the following risk decrease. The analysis predicts that the critical performance threshold which triggers firing increases significantly over a manager's tenure and that management replacements are accompanied by capital inflows when a young manager is replaced, but may be accompanied by capital outflows when a manager with a long tenure is fired. Our model yields much lower valuation levels for management companies than simple applications of DCF methods and is thus more consistent with empirical observations.

Keywords: mutual funds, portfolio management, governance, market discipline

JEL Classification: G10, G20

Suggested Citation

Dangl , Thomas and Wu, Youchang and Zechner, Josef, Market Discipline and Internal Governance in the Mutual Fund Industry (February 2005). ; AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=663443 or http://dx.doi.org/10.2139/ssrn.663443

Thomas Dangl

Vienna University of Technology ( email )

Theresianumgasse 27
Vienna, A-1040
Austria

Youchang Wu (Contact Author)

University of Oregon ( email )

1280 University of Oregon
Eugene, OR 97403
United States

Josef Zechner

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien A-1019
Austria

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