Gerald Davis and E. Han Kim
Mutual Funds May Bite the Hand That Feeds Them - But Not Always
New study shows that mutual fund companies that do a lot of pension business tend to vote with management.
ANN ARBOR, Mich.—The more business ties a mutual fund company has, the more likely it is to vote against shareholder proposals opposed by management, a new University of Michigan business school study shows.
Researchers Jerry Davis and Han Kim of Michigan's Stephen M. Ross School of Business say that a positive link exists between a mutual fund company's volume of pension business and its propensity to vote with management.
"Client ties matter at the voting policy and guideline level," said Davis, professor of management and organizations at the Ross School of Business. "Although a mutual fund company with heavy business ties may want to avoid nepotism, it has an incentive to adopt a voting policy that leads to fewer votes against management in general, thereby reducing the risk of alienating the management of client firms.
"A fund family with fewer client ties, however, does not have the same incentive because it may consider that the benefits of voting in accordance with shareholders outweigh the risk of offending management."
In their study, "Would Mutual Funds Bite the Hand that Feeds Them? Business Ties and Proxy Voting," Davis and Kim address the relative silence of mutual fund companies regarding corporate governance issues.
"To the extent that good corporate governance leads to higher valuation in stock markets, fund managers have incentives to use their voting power to demand good corporate governance," said Kim, professor of finance and international business at the Ross School. "However, such fiduciary responsibilities may be compromised if mutual fund parents also manage corporate benefits, such as 401(k) plans, at the behest of management."
The researchers analyzed conflicts of interest in proxy voting at Fortune 1000 companies by using newly available data on the voting records of 21 mutual fund companies. They examined proxy votes on several major corporate governance-related shareholder proposals, including classified (or staggered) boards, independent board chairs, expensing options, poison pills, golden parachutes and cumulative voting.
Even after controlling for other factors, the researchers found that the volume of pension fund business appears to affect how fund companies voted on most of these proposals.
On the whole, Davis and Kim say that while the number of clients has a significant and negative influence on the likelihood of funds to vote in favor of shareholder proposals, their votes can be explained by the policies of their parent companies.
They found that levels of ownership are essentially independent of individual client relationships between mutual funds and firms, and that funds are no more likely to vote with management at client firms than non-clients.
Failure to detect a significant link between proxy voting and individual client ties is not surprising, the researchers say, given that the proxy voting in their study took place during a period when mutual funds' votes were under close public scrutiny (July 2003-June 2004).
"The mutual fund industry has been subject to numerous scandals involving conflicts of interest such as market timing, late trading and sales practices," Kim said. "Given the recent vigilance of the SEC and (New York State Attorney General) Eliot Spitzer, the risk of another scandal and the ensuing lawsuits and public fines was perhaps sufficient to deter mutual funds from voting differently between clients and non-clients, even if that was the standard practice before the mandatory disclosure of proxy votes."
The researchers say that many mutual fund companies have, instead, adopted a less risky strategy under the current regulatory climate that leads to less frequent voting against management recommendations---policies that favor clients without appearing nepotistic.
"Mutual funds may have to bite some feeding hands in order to appear even-handed, yet they also have incentives to create policies that lead to less hand-biting," Kim said. "These incentives are greater the more feeding hands there are for a mutual fund company."
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