China's Securities Investment Fund Effectiveness Study Dual Internal Governance Structure

Because of flaws in contractual mutual funds’governance structure, Chinese regulators ask the board of directors as well as independent directors of fund management companies to protect the fund investors, while maximizing their shareholders’interests. This is the unique dual role of internal governance in China’s mutual fund industry.Based on classical theories of corporate governance, we applied the unbalanced panel data regression model on the performance of China’s mutual funds as well as fund management companies during the period2007-2010, trying to answer three questions related to the dual role of fund internal governance:First, what is the effect of internal governance on the performance of the management company? Second, what is the effect of internal governance on the performance of the mutual fund itself? Third, are these two roles mutually conflicting or integrated? If they are integrated with each other, what is the mechanism that links them together?Our empirical study indicates that:i) Internal governance has significant positive effects on the performance of the management company. If the percentage of independent directors on the board increases by1%, the return of assets (ROA) will rise by0.06%. The size of board of directors has a nonlinear inverted U-shaped relationship with the performance, and the optimal number of directors is8to9persons.1%increase in the position of the biggest shareholder of the management company will cause0.0033%rise in the ROA.ii) Internal governance also has significant positive effects on the performance of the mutual fund itself. If the percentage of independent directors on the board increases by1%, fund performance measured by percentage rank of primary return, Jensen’s alpha and Sharpe ratio will rise0.24%,1.74%and0.49%respectively. The size of board of directors has a nonlinear inverted U-shaped relationship with the fund performance, and the optimal number of directors is around9persons.1%increase in the position of the biggest shareholder of the management company will cause fund performance measured by percentage rank of primary return. Jensen’s alpha and Sharpe ratio to rise0.88%,0.20%and0.27%respectively.iii) The flow-performance relationship on China’s mutual fund market is "return chasing". One year lagged return has positive effect on the fund flow; mutual funds with superior performance will attract more inflow. Investors’return chasing behavior is such a positive incentive that integrates the dual role of internal governance in China’s mutual fund industry, which well explains the empirical result that internal governance has positive effects on the performance of both the fund management company and the mutual fund itself.Result of this paper shows that the dual internal governance structure of China’s mutual funds is effective.