A paper that is to be published in the Journal of Financial and Quantitative Analytics examines how mutual funds influence corporate governance of portfolio companies. Because mutual funds own one-quarter to one-third of the shares in U.S. companies, the authors find that their potential corporate governance influence is significant. The paper examines how mutual funds register opposition to management, finding two major approaches:
- The Wall Street rule – where funds sell shares to register opposition to management or
- Directly intervening by voting against management (known as “voice”).
To study these governance options, the authors identified proxy proposals where the company management’s vote recommendation differed from the recommendation of ISS (“Oppose Management Proposals”). The authors compiled the voting records of the 100 largest mutual fund families and their exit and non-exit decisions from July 2003 through June 2012. Their database of information for the paper also included the voting recommendations from ISS and company management for every proposal regarding a Russell 3000 company. Using this data, the paper finds that
- 51.31% of funds vote against management on Oppose Management Proposals (compared to only 3.48% on other proposals)
- 9.75% of funds exit on Oppose Management Proposals (compared with 8.73% on others).
The authors find that governance through voice is particularly easy for funds because it is virtually costless as compared to other forms of intervention, such as forcing out a company CEO. In addition, these funds may simply have to follow the ISS recommendation. The authors find evidence to support that the results on the Oppose Management Proposals are not simply driven by ISS recommendations.
The paper also examines situations where funds may be more or less likely to exercise a particular governance option on an Oppose Management Proposal. The authors find that funds that own a large block of the company stock are less likely to exit due to liquidity constraints, and therefore have a strong incentive to use voice. The authors also find that funds with higher turnover are more likely to exit a company. Examining characteristics of the portfolio companies, the paper finds that funds are more likely to exit on small companies. Similarly, funds are more likely to exit in cases where insiders own a larger portion of the company and where a particular stock is more liquid.