Can There Be Too Much Competition in Financial Services? Evidence from British Mutual Funds

Posted by D. Daniel Sokol

A. Joseph Warburton, Syracuse Univ. - College of Law, Syracuse Univ. - Whitman School of Management
 asks Can There Be Too Much Competition in Financial Services? Evidence from British Mutual Funds.

ABSTRACT: This paper explores the effects of competition on risk-seeking behavior and firm performance within the financial services industry. It does so by exploiting a change in British mutual fund regulations that lowered a barrier to entry. In 1997, British regulators removed a requirement that mutual funds organize as trusts, freeing them to organize as either trusts or corporations (trust law subjects fund managers to stricter fiduciary responsibilities than corporate law does). Exploiting this regulatory shock, I trace non-trivial linkages among industry competition, risk taking, and performance. After the removal of the entry barrier, the industry experienced an increase in competition. Increased competition led to a significant increase in risk-taking behavior. Results suggest that increased competition also generated an improvement in risk-adjusted performance. While competition did not produce tangible cost savings for consumers, it did mitigate certain harmful investor behaviors, such as chasing past performance.