What's the inside word? Director-affiliated stocks in mutual funds

(with Lei Wedge)

We document that equity mutual funds own stocks of firms whose senior officers also serve as independent fund directors. Funds invest relatively more in their "director-affiliated" stocks, and exhibit superior timing ability in the liquidations of such stocks. Specifically, funds liquidate director-affiliated stocks in advance of declining return performance, and post-liquidation return declines are significantly worse than those for unaffiliated stocks that funds liquidate during the same quarter, a result not explained by stock characteristics. Funds that trade in director-affiliated stock appear to successfully exploit and information advantage over other investors, which may warrant further investigation about full compliance with securities regulations.

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