Working Paper | HBS Working Paper Series | 2014

Friends with Close Ties: Asset or Liability? Evidence from the Investment Decisions of Mutual Funds in China

by Xinzi Gao, T.J. Wong, Lijun Xia and Gwen Yu

Abstract

When fund managers have close ties to their investees, it can facilitate efficient information sharing but can also increase the possibility of favoritism. Using the investment choices of mutual funds in China, we test whether funds with close ties to their investees make timelier investment decisions—i.e., they purchase (sell) prior to positive (negative) investee performance. We measure close ties using the education network between fund managers and managers of the investee firms. We find that having close ties to an investee leads to more timely investments only when the funds are closely monitored. For poorly monitored funds, we find that having close ties can lead to less timely investments. Further examination shows that the reduced timeliness of connected funds is driven by a reluctance to withdraw holdings prior to weak investee performance. We interpret this as agency conflicts from delegated portfolio management reducing the information sharing role of close ties and leading to collusion when the counter party is in need. The findings suggest that close ties lead to timely investment decisions only when the informed parties are free of agency conflicts.

Keywords: social ties; Conflict of Interests; Asset Management; Investment Portfolio; Networks; Financial Services Industry; China;

Citation:

Gao, Xinzi, T.J. Wong, Lijun Xia, and Gwen Yu. "Friends with Close Ties: Asset or Liability? Evidence from the Investment Decisions of Mutual Funds in China." Harvard Business School Working Paper, No. 14-086, March 2014.