Fund Share Gains Lead to Borrower Pains: Investor Competition and the Cost of Capital

I argue that delegated investors form oligopsonies in the short-term securities market, and their competition affects borrowing costs. In particular, I document that the enactment of Money Market Mutual Fund reforms on October 2016 prompted many delegated asset managers to exit the market for short-term securities and increased the concentration of remaining investors, especially in the tax-exempt categories. Subsequently, tax-exempt funds obtained after-tax portfolio yields that were 27 basis points higher than comparable taxable funds. Consistent with pricing power, the largest fund families received higher promised returns (up to 10 basis points) than smaller families on the same class of assets. Additionally, I show that the remarketers set higher payment rates for short-term securities directly held by their affiliated funds. These results highlight the trade-off in enacting macro-prudential policies and encouraging capital market efficiency.