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Whom Can You Trust? A Study on Mutual Fund Governance

Investors in an open-end mutual fund can vote with their feet by withdrawing assets from or adding assets to the fund. This paper examines the effectiveness of this market monitoring mechanism in relation to the trading scandals erupted in 2003. With a sample of 92 fund families and 10220 funds*classes I find that the probability of being indicted is higher for younger funds, funds whose boards are excessively paid, and funds whose money flow is insensitive to past returns. In funds with higher flow sensitivity, there are less stale pricing and less abnormal flows, implying less opportunistic trading. These findings suggest that investors' ability to withdraw from or add assets to funds is an effective fund governance mechanism.