Tuesday, October 12th @ 11:00am-12:30pm Pacific Time
Insuring against wrongdoing? Socially responsible investing by mutual funds
Vikramaditya (Vic) Khanna, University of Michigan
ABSTRACT: We examine whether mutual funds increase the level of their socially-responsible investing (SRI) to reduce the negative consequences stemming from alleged wrongful behavior by fund insiders. Relying on a novel hand-collected dataset covering 17 years of funds’ fidelity bond claims (for theft and embezzlement by insiders) and errors and omissions claims (for mistakes) we find that funds significantly increase their SRI in the year of a claim, but not in the year before or after the claim. These results are robust to matched firm methods and instrumental variable regressions and are very similar to increases in SRI when the mutual fund trading scandals of 2003 were revealed. Further, for funds which aggressively increased their SRI, the negative flow effects usually associated with filing these claims largely dissipates. These funds are also less likely to replace their managers. These steps are not costless because the increase in SRI for these funds reduces returns by approximately 68 basis points per month in the next period. Our findings suggest that funds rely on strategic SRI investing in the year of a fidelity bond claim to repair their weakened reputations, at non-trivial costs in returns. Our findings are, to the best of our knowledge, the first in the mutual fund literature finding that strategic increases in SRI aid in reducing the negative effects arising from the announcement of bad news and thereby create an ex post halo effect partially repairing the fund’s reputation.