Do Pension-Related Business Ties Influence Mutual Fund Proxy Voting?

The following post comes to us from Rasha Ashraf of the Department of Finance at Georgia State University; Narayanan Jayaraman, Professor of Finance at the Georgia Institute of Technology; and Harley Ryan of the Department of Finance at Georgia State University.

In the paper, Do Pension-Related Business Ties Influence Mutual Fund Proxy Voting? Evidence from Shareholder Proposals on Executive Compensation, which can be found in a forthcoming issue of the Journal of Financial and Quantitative Analysis, we examine the relation between mutual fund votes on shareholder executive compensation proposals and pension-related business ties between fund families and the firms. Mutual funds have a fiduciary responsibility to act in the interests of their shareholders. Shareholder proposals provide one mechanism via which mutual funds can influence firm policies to benefit shareholders. However, mutual funds benefit when they receive pension fund business from firms, which creates a potential conflict of interest that creates an incentive for fund managers to support firm management and to vote against shareholder proposals. Rationally, fund families should trade off the economic benefit of self-interested voting against possible economic losses related to lower portfolio returns, damaged reputations, or potential lawsuits. Shareholder proposals that relate to executive compensation provide an excellent arena in which to examine the influence of pension-related business ties, since these proposals can directly affect the pay and benefits of managers with influence over which fund families receive pension business.

We find a strong negative relation at the firm proposal level between the likelihood that a mutual fund supports shareholder-sponsored compensation proposals and its pension-related business ties to the firm. Except for proposals to expense options, we document no relation between fund voting and pension ties when we use a conditional logit stratified by fund family to control for fund-family fixed effects. The evidence of a fund-family fixed effect suggests that fund families vote with management at both client and non-client firms, possibly to protect their reputations or to avoid the potential for lawsuits. We confirm this result in a direct examination of voting by fund families with pension-related business ties on proposals at non-client firms. Taken together, our results indicate that pension-related business ties influence how fund families vote at all firms.

We do not presume that all shareholder proposals that relate to compensation should be implemented or that firms that receive such proposals have ineffective compensation policies. In the debate on the efficacy of executive compensation, however, activists and policy makers have long proposed that executive compensation and benefits packages be put to shareholder vote. Our results also shed some light on the usefulness of recently implemented disclosure policies to mitigate potential conflicts of interests in mutual funds. Although we cannot compare the influence of business ties after the implementation of the disclosure rule to the influence of business ties prior to implementation, our results confirm that conflicts of interest persist in the post-disclosure era.

There are costs and benefits to any principal–agent relationship, and it is not possible to write complete contracts or to monitor perfectly. Mutual funds have persisted for a long time, and thus would appear to be an equilibrium mechanism to facilitate efficient investment in a large portfolio of stocks by diffuse shareholders. We cannot directly conclude from our findings that shareholders are harmed by the tendency of mutual funds with pension-related business ties to support management on shareholder-sponsored executive compensation proposals. However, it appears that “management friendly” fund families get most pension fund management business. This finding suggests that agency problems are likely prevalent among firm managers who choose the pension fund manager as well as in the fund family.

The final version of the working paper is available for download here.

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One Comment

  1. Paul
    Posted Wednesday, January 11, 2012 at 4:53 pm | Permalink

    This is an excellent paper. I think it shows that the plans in the UK to limit director pay through giving investors a vote on the matter is ultimately doomed.

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