Inheriting Losers

Abstract

We show that new managers who take over mutual fund portfolios typically proceed to sell off inherited momentum losers. They sell losers at higher rates than stocks in any other momentum decile, even after adjusting for concurrent trades in these stocks by continuing fund managers. This behavior persists even when managers take over well-performing funds and funds with positive fund flows where it is unlikely that they are expected to change fund strategy or sell holdings to meet redemption demand. We conjecture that continuing fund managers tend to hold on to losers because of their inability to ignore the sunk costs associated with the stocks' past underperformance. Furthermore, we present evidence that the sell-off creates price pressure in the market by showing that the losers inherited in high quantities by new managers experience negative abnormal returns in up to two weeks following the completion of managerial change.

Keywords: Sunk-Cost Fallacy, Price Pressure, Managerial Turnover

JEL Classification: G11, G14, G23