Mutual fund cliques, fund flow-performance sensitivity, and stock price crash risk

Abstract

This paper examines the relationship between mutual fund cliques and firm's stock price crash risk under different constraints of fund flow-performance sensitivity (FPS). Employing a panel data of Chinese A-share listed companies from 2006 to 2021, we find that mutual funds are likely to work together and cluster holdings (cliques), which significantly impede firm governance, decrease the quality of information disclosure, and promote crash risk. In particular, the price impact is more pronounced in higher-FPS situations. We also nest a standard model of performance-based arbitrage (PBA) to theoretically explain the function of FPS, which suggests that fund shareholders always have irrational performance preferences when evaluating fund managers' arbitrage ability, and this specialized arbitrage may expose prices to non-fundamental pressure from mutual fund flow-induced variation. After identifying coordinated group (clique) holdings and their firm-level FPS, we provide empirical evidence for the application of the PBA model in China's capital market.