Does Ethical Reinforcement Pay? Evidence from the Canadian Mutual Fund Industry in the Post‐Financial Crisis Era

• Date: 01 March 2019
• Author: Mohamed A. Ayadi,K. Smimou
• DOI: http://doi.org/10.1111/basr.12164
• Published date: 01 March 2019

Business and Society Review 124:1 73–114

© 2019 W. Michael Hoffman Center for Busi ness Ethics at Bentley Univer sity. Published by

Wiley Period icals, Inc., 350 M ain Street , Malden, MA 02148, USA , and 9600 Ga rsington

Road, Oxford OX4 2DQ, U K. DOI: 10.1111/basr.12164

Does Ethical Reinforcement

Pay? Evidence from the

Canadian Mutual Fund

Industry in the Post-Financial

Crisis Era

K. SMIMOU and MOHAMED A . AYADI

ABSTR ACT

This study elucidates the link a nd effect of ethical rein-

forcement in the post-financial crisis era by taking two con-

gruent directions to demonstrate t hat ethical rein forcement

can be accomplished by either a continuous ethical t rain-

ing or a meticulous code of business ethics—wh ich mem-

bers of the mutual fund industr y claim they adhere to—as

both have a positive effect on the funds’ performa nce,

including sizeable gain s to investors. Further more, evi-

dence divulges that eth ical reinforcement moderates the

perform ance of ethical or socially respon sible investments

(SRI) f unds more than noneth ical i nvestments, sug gest-

ing that a perspective of et hical or SRI clas sification of a

fund alone is not sufficient, but it is necessary to have the

institut ional ethical environment and/or managers’

K. Smimou is a n associate profess or of finance at t he Faculty of Busines s, University of Ont ario

Institute of Tech nology, Oshawa, Ontario L1G 0C5, Can ada. E-mail: Kama l.smimou@uoit.ca.

Mohamed A. Ayadi i s a professor of finance in Goo dman School of Bu siness, Depar tment of

Finance, O perations and Infor mation Systems, Brock Un iversity, St. Cathar ines, Ontario L2 S

3A1, Canada. E-ma il: m.ayadi@brocku.ca.

74 BUSINESS AND SOCIETY REVIEW

continuous ethical tra ining. Th is result supports the

notion of financial market discipline and reveals some

factors behind SRI or ethica l funds returns, notably dur-

ing the period followi ng the recent fina ncial crisis.

INTRODUCTION

T his research ex amines the relationship between mutual

fund performance and fund managers’ characteristics when

they are subject to ethical rei nforcement (within t he fund

company that the mana ger works for). We address four related

questions. First, what is the relationship between ma nagerial

characteristics a nd fund performance? Second, within that rela-

tionship, how does the presence of ethical rein forcement reshape

and affect the ma naged fund’s performance? Thi rd, is there any

significa nt difference in terms of per formance between those

claimed to be SRI or et hical mutual funds versus conventional

funds?1 And fourth, from a Canadian perspective does the pres-

ence of ethical reinforcement or stimulus moderate or engender the

difference between those t ypes of mutual funds?

Clearly, the answers to the above four questions are complemen-

tary si nce the motivations of fund mana gers when they are subject

to additional ethica l reinforcement must be consistent with their

style and as well as be consistent with t he actual performa nce

of the funds (Mackenzie and Lewis 1999; Rivoli 20 03). Ethically

conditioned (a nd ethica lly concer ned) fu nd managers have incen-

tives to follow a rigorous method and process when constructing

portfolios and selecti ng investments in order to avoid holding poor

investments while being f ully consistent with the objective a nd

strategy of the fund, including adherence to the guidelines and

ethica l standa rds of the pr ofession.

This study connects two aspects of the literature. The first as-

pect focuses on the linka ge between preferences of different inves-

tors or managers who share a common bond, either professionally

or socially, which helps to establish common views as well as

long-lasting relationships. Another group of studies emphasizes

ethical considerations that ex amine the t rade-off between moral

and financial values, as well as studies that extend our under-

standing beyond shareholders wealth maxi mization to include all

75SMIMOU AND AYADI

of the firm’s stakeholders, in line wit h the theory of sta keholders

and the various interact ions with the psychology of man agers and

investors (e.g., Freeman 1984; Friedman and Mi les 2002; Harti ng

et al. 2006; Mackenzie and L ewis 1999). The second aspect in-

volves examin ing patterns of man agerial behav ior and resulting

fund performance, notably studies related to fund manager char-

acteristics and mutual fund performance (Chevalier and Ellison

1999a, 1999b; Dahlquist et al. 2000; Golec 1996).

The 2008 global financial cr isis (GFC) put a heavy burden on

the equity markets of ma ny nations, including the Europea n

countries, especially the Eurozone nations. The GFC has not only

led to worldwide recession, unemployment, macroeconomic imbal-

ances, and bank ing sector problems; it has also led to an erosion

of trust and a concomitant r ise of distrust but at the same time it

put the limelight on the underlying microstructure foundations,

restoring tr ust in finance a nd motivating the need for more stable

markets (see also, Werhane et al. 2011). Therefore, it is relevant to

examine t he human characteristics including trust that somehow

engender and alter investment strategies, and if we t hink th at the

mutual fund managers’ ethical considerations should reveal in for-

mation about fund performance. T his psychological factor exhibits

a time-var ying pattern guided by external information shocks that

affect the investment decision, notably during a crisis. During pe-

riods of crisis, investment strategies (for insta nce) may not prove

to be effective, as many fu ndamental (and psychological) factors

change and al l sectors may become more correlated (e.g., Fabozzi

et al. 2010). Our investigation is i n line with t hat reasoning as

we analyze t he role of ethical reinforcement in mutual f und man-

agement. Fu rther more, our ex amin ation responds t o the concer ns

that fina nce ethics is in need of fur ther scholarly attention as little

attention is given to financial topics by business ethics scholars

(Boatright a nd Peterson 2003).

We argue that ethical t raining and social interaction of the mu-

tual fund ma nagers within a team env ironment influences financi al

decisions (Grinblatt et al. 2012), while they fulfill t heir fiduciary du-

ties and protect investor interests (Rubin 2015). In line with Massa

and Simonov (2011), who examine the link between colleague inter-

action and portfolio choice, we contend that ethical rei nforcement

inf luences the choice of investing style as well as stock selection, in-

vestment strategies, and subsequent portfolio performa nce. Massa