External Monitoring and Dynamic Behavior in Mutual Funds

Abstract

This paper studies the impact of external monitoring on the behavior in mutual funds. Specifically, we investigate how and why external monitoring can alleviate contracting inefficiency caused by information asymmetry between investors and the manager. It is shown that efficiency loss emerges when investors contract with the manager just relying on her investment return history. The establishment of external monitoring that provides investors more information about the manager's ability can improve contracting efficiency, which converges to first-best as external monitoring strengthens. These results provide strong support for tightening supervision in mutual fund industry.