Reputation acquisition: The role of the fund family in the mutual fund industry

In 1940, Congress established a unique governance system for mutual funds. Fund directors bear all the responsibilities expected of corporate directors and some required by the Investment Company Act of 1940 and by numerous SEC rules. Mutual funds are the only businesses required by law to have independent directors. The purpose of this law is to protect the interests of fund shareholders. But, when it comes to performance, trustees and management sit on the same side of the table. We examine the conflict of interest arising out of this evaluation of performance.; Part I models the conflict of interest when fund families certify a manager's quality by setting an evaluation standard to evaluate their managers. The more stringent an evaluating standard, the more costly it is but they have to weigh the gain from supporting bad managers against a loss of reputation from not evaluating managers correctly. Rational investors anticipate which family has a conflict of interest and find it rational to stay invested with the fund irrespective of performance of the manager conditional on what they know about the past actions of the fund family. In equilibrium, because of reputation concerns, the fund family's choice is influenced by the effect of their action on investor confidence. The equilibrium is such that the beliefs of the fund family and the investors and their optimal actions are mutually rational and consistent.; Part II of the thesis investigates this role of the fund family by examining performance, cash flow, and managerial turnover. We use monthly data on returns and cash flows and manager replacements to examine the relationships between investors, the fund family and the fund manager. The evidence shows that investors are more forgiving of poor performance and more rewarding of good performance in large fund families. When a manager is changed, cashflow is positive to funds in large families. This investor behavior is consistent with a reputation role for the fund family, where investors extract information from the firing/retaining decision of the fund family in addition to fund performance. Is investor trust misplaced? No, funds in large fund families do behave differently. The worst performers in large families do not repeat their bad performance, while those in small families do. After a manager change, large family funds show a larger improvement in performance. Also, in their first few years, new funds in large fund families perform better than new funds in small fund families.