Friday, October 5, 2012

CHENG Si, MASSA Massimo, ZHANG Hong
Short-sale Constraints and the Pricing of Managerial Skills: The Case of Mutual Funds
INSEAD Working Paper 2012/92/FIN 

We study how firms price discriminate in the presence of short-selling constraints. We focus on the mutual fund industry and we investigate the impact of the inability to short-sell mutual funds on the market for managerial value. We argue that in the presence of different opinions on managerial skills, managers can charge fees that are higher than the value (performance) that they deliver. Doing this allows them to price discriminate and to attract only the most optimistic capital. We show that this helps to explain a series of stylized observations and puzzles in the mutual fund industry, including the underperformance of active funds, the existence of flow convexity, and the negative correlation between gross-of-fee α and fees.