ETFs as a disciplinary device

We document a novel feature of active exchange-traded funds (AETFs): they serve as a disciplinary tool for investors to remove underperforming portfolio managers. Unlike mutual fund shares, ETF shares can be shorted, which enables investors to bet against manager performance. We show that AETFs exhibit over five times greater flow-performance sensitivity than mutual funds, indicating that AETF managers face harsher penalties for poor performance. When an underperforming manager joins an AETF, investors respond by shorting more shares of the fund. Consequently, this manager is more likely to exit the fund management industry, thereby enhancing overall sector efficiency and allowing more high-performing managers to remain. Moreover, the stocks held within AETFs exhibit improved price informativeness. We also find that AETF managers outperform both mutual fund and passive fund managers. In summary, the short-selling feature of AETFs serves as a disciplining device and enhances market efficiency by facilitating the removal of underperforming managers.