6.3 The Threat of Exit in Mutual Funds

Sale prices in mutual funds, by contrast, do not reflect expected returns. Rather than selling their shares on the market, shareholders in mutual funds who are dissatisfied with the fund advisor's compensation level can redeem their shares and receive a cash amount equal to a pro rata share of the fund's assets (after debts and liabilities), which is called the net asset value per share ("NAV"). This cash amount should suffice to buy a substitute share in a different mutual fund with the same NAV but with higher expected returns because of lower fees. As a result, shareholders whose concerns are ignored do not face a similar barrier to exiting as shareholders in corporations do, and the threat of exit is very credible. Fund advisors will generally want to prevent dissatisfied shareholders from exiting, as their compensation is usually tied to the amount of assets onder management. All else being equal, this should make fund advisors more responsive to shareholders' concerns, and this, in turn, makes voice more attractive.

Importantly, the significance of a dissatisfied shareholder's threat of exit depends not only on how credible the threat is, but also on the number of shares that the shareholder would redeem. Given that shareholders in mutual funds are typically household investors, this number is generally low. The fund advisor, therefore, would not need to bother when a shareholder informally voices concerns, unless of course there is reason to believe that the concerns are tacitly shared by a wider group of shareholders. Thus, share-ownership dispersion acts as a double-edged sword: it discourages voice not only by creating collective action problems, but also by diluting the threat of exit and hence the likelihood that voice will be effective.