The Economic Consequences of Mutual Fund Advisory Misconduct

Abstract

We evaluate the economic consequences of mutual fund advisory misconduct from 2000 to 2015. An average of 31.25% reduction in monthly fund flows occurs in one year after the misconduct. The effect is more pronounced in funds facing strong investor monitoring. Although all types of misconduct have negative effects on sentiment-driven flows, only disclosure-related misconduct has negative effects on fundamental-driven flows. To respond, mutual funds raise marketing expenditures, reduce contractual incentives, impose stricter investment restrictions, hold more liquid assets, and replace malfeasant advisory firms subsequently. These measures alleviate the adverse effects of misconduct on investor flows. Overall, our study highlights the significant impact of misconduct on mutual fund flows and responsive policies in the mutual fund industry.