The distorting effect of the prudent-man laws on institutional equity investments

I examine the effect of prudent-man laws on the behavior of institutional investors. Variation in exposure to legal liability across types of investment managers allows me to disentangle the effect of the prudent-man laws from other potential influences on manager behavior. Bank managers significantly tilt the composition of their portfolios toward stocks that are viewed by the courts as prudent, while mutual fund managers do not. I show that differences in the direction that bank and mutual fund managers choose to tilt may explain their portfolio performance differences over time.