Mutual Funds

1
Determinants and Consequences of Proxy Voting by
Mutual Funds on Shareholder Proposals
Rasha Ashraf Narayanan Jayaraman December 13,
2006
2
Motivation

• An important corporate governance mechanism is
  voting rights of shareholders
• Institutional investors take the responsibility
  to vote on behalf of individual investors.
• Institutional investors hold 66 of U.S. stocks.
• Total assets of mutual funds
• 1950 2 billion
• 2006 10 trillion

3
Motivation

• With more than 25 of all U.S. stocks under their
  control, mutual funds could practically run the
  business world, working with other large
  investors to throw out overpaid CEOs and force
  corporate overhauls. But they don't.
• WSJ, October 3, 2006
• Fidelity holds a 10 or greater stake in at least
  100 of the nation's largest 1,000 companies and,
  controls at least 1.3 trillion, more than all
  hedge funds combined. But Fidelity rarely
  exercises its unprecedented muscle to push for
  improved corporate governance.
• Business Week, October 16, 2006

4
Objective

• Study the determinants of mutual funds voting
  policies across firms.
• Examine the incentive structure of mutual funds
  to undertake activist role in voting behavior.
• Investigate whether mutual funds engage in Wall
  Street Walk when dissatisfied with management.

5

• In 2002 SEC Reports
• Traditionally mutual funds have been viewed as
  largely passive investors, reluctant to challenge
  corporate management on issues such as corporate
  governance. Funds have often followed the so
  called Wall Street Rule according to which an
  investor should either vote as management
  recommends or if dissatisfied with management,
  sell the stock.

6
History of Mutual Funds Disclosure Policy

• In December 2000 SEC started to examine the
  proxy vote disclosure issue for mutual funds
• In September, 2002 SEC propose to consider
  requiring mutual funds to disclose their proxy
  voting policies and actual votes cast.
• There was unanimous opposition by the mutual
  funds on this proposal.
• In January, 2003 SEC adopt new rule which made
  disclosure of proxy voting policies and
  procedures mandatory
• File new Form N-PX, containing proxy voting
  records for the 12-month period ended June 30 by
  no later than August 31 of each year.

7
Literature Mutual Funds Voting Behavior

• Rothberg and Lilien (2005) analysis of the
  largest 10 fund families proxy voting policies.
• Davis and Kim (2005) conflict of interests of
  mutual funds in their voting behavior

8
Shareholder Proposals and Shareholder Activism

• Survey
• Gillan Starks (1998)
• Karpoff (2001)
• Black (1998)
• Romano (2001)
• Other Studies
• Karpoff, Maletesta, Walking (1996)
• Ertimur, Ferri and Stubben (2005)

9
Data

• Proxy voting records in shareholders proposals
  for the period July 1, 2003 to June 30, 2004.
• Proxy voting record in Form N-PX would include
• Identification of the company and the proposal
• Sponsor of the proposal management or
  shareholder
• Whether the fund voted on the proposal or not.
• How the fund voted for against abstain
  unknown
• Whether the fund voted for or against management
  for against unknown
• 24 biggest fund families based on the total net
  assets for the year 2004.
• 433 mutual funds
• Over 29,000 observations covering 528 firms.

10
Data

• CRSP mutual fund database fund performance and
  characteristic data
• Thomson Financial Mutual Fund Holding Database
  mutual fund holdings data.
• CDA-Spectrum 13-f filings Mutual fund families
  holdings data
• CRSP Returns, share outstanding and market
  capitalization
• COMPUSTAT firms earnings data
• Compact Disclosure SEC data source Blockholder
  and insider holdings data
• Gompers-Ishii-Metrick governance score data

11
Types of Shareholder Proposals

• Total 74 types of shareholder proposals
• Seven broad categories
• Anti-takeover
• Voting Issues
• Shareholder Wealth and Rights
• Executive Compensation
• Director Related
• Audit Committee
• Other Social and Ethical Issues

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Anti-takeover

1. Supermajority Provision Shareholder vote
   requirements are higher than the minimum levels
   set by state law to approve a merger or other
   business combination.
2. Poison Pill Shareholders are issued rights to
   purchase stock in their own company or in the
   acquiring company at a steep discount if a
   hostile bidder acquires companys shares.
3. Classify Board It is also known as staggered
   board. The board is divided into classes, with
   the directors in each class serving overlapping
   terms.
4. Golden Parachutes A contract specifying that
   executive will receive large benefits in the
   event that the company is acquired and the
   executive's employment is terminated.
5. Opt Out of State Takeover Statute Most state
   anti-takeover provisions allow companies to "opt
   in" or to "opt out" of coverage by stating their
   intention in their charters.

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Table 2 Descriptive Statistics of Sample Fund
Family Voting
Management Name Total Number of Voting Records in Sample Vote Cast for Vote Cast against Vote Cast abstain Vote Cast unknown
1 Fidelity Management Research 3844 0.167 0.705 0.123 0.005
2 Dreyfus Corporation 971 0.192 0.784 0.025 0.000
3 Capital Research Management Co. 2245 0.181 0.774 0.009 0.036
4 Deutsche Asset Management 2456 0.321 0.677 0.002 0.000
5 Vanguard Group Investment Co. 3350 0.192 0.484 0.324 0.000
6 Franklin Advisers Inc. 1290 0.197 0.759 0.031 0.013
7 Federated Investment Management Co 623 0.061 0.934 0.005 0.000
8 AIM Advisors Inc. 1368 0.185 0.645 0.167 0.002
9 Smith Barney Asset Management 1004 0.276 0.713 0.009 0.002
10 Putnam Investment Mgmt LLC 1456 0.158 0.830 0.011 0.001
11 Alliance Capital Management Corp. 290 0.241 0.710 0.048 0.000
12 Prudential Securities Incorporated 1055 0.269 0.572 0.159 0.000
13 Allianz Dresdner Asset Mgmt 448 0.467 0.513 0.020 0.000
14 Merrill Lynch Investment Managers 817 0.206 0.785 0.010 0.000
15 OppenheimerFunds 1027 0.155 0.472 0.373 0.000
16 MFS Investment Management 1587 0.129 0.858 0.013 0.000
17 Columbia Management Group Inc. 402 0.356 0.582 0.060 0.002
18 Goldman Sachs Asset Management 78 0.244 0.756 0.000 0.000
19 Morgan Stanley Investment Advisors 1213 0.153 0.838 0.007 0.003
20 American Express Financial Advisors 869 0.119 0.873 0.005 0.003
21 ING Investments LLC 460 0.161 0.817 0.022 0.000
22 Banc One Investment Advisors 453 0.302 0.671 0.026 0.000
23 JPMorgan Fleming Asset Management 970 0.340 0.660 0.000 0.000
24 T Rowe Price Associates Inc. 1445 0.241 0.754 0.001 0.005
Total Number of Proposals 29795 0.221 0.715 0.060 0.003
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Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Table 3 Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families
Management Name ANTITAKEOVER VOTING ISSUES SHAREHOLDER WEALTH AND RIGHTS EXECUTIVE COMPENSATION DIRECTOR RELATED AUDIT OTHERS
1 Fidelity Management Research 0.756 0.112 0.219 0.087 0.139 0.224 0.007
2 Dreyfus Corporation 0.770 0.056 0.172 0.067 0.111 0.250 0.031
3 Capital Research Management Co. 0.680 0.509 0.244 0.022 0.119 0.100 0.053
4 Deutsche Asset Management 0.826 0.321 0.515 0.083 0.310 0.200 0.080
5 Vanguard Group Investment Co. 0.636 0.041 0.247 0.017 0.065 0.294 0.056
6 Franklin Advisers Inc. 0.559 0.433 0.282 0.182 0.385 0.333 0.025
7 Federated Investment Management 0.472 0.021 0.000 0.000 0.000 0.000 0.000
8 AIM Advisors Inc. 0.681 0.450 0.129 0.110 0.239 0.092 0.056
9 Smith Barney Asset Management 0.765 0.406 0.342 0.122 0.200 0.143 0.090
10 Putnam Investment Mgmt LLC 0.865 0.053 0.072 0.009 0.194 0.000 0.008
11 Alliance Capital Management Corp. 0.500 0.250 0.333 0.255 0.200 0.333 0.059
12 Prudential Securities Incorporated 0.786 0.424 0.316 0.150 0.377 0.747 0.010
13 Allianz Dresdner Asset Mgmt 0.648 0.333 0.512 0.131 0.417 0.250 0.083
14 Merrill Lynch Investment Managers 0.548 0.308 0.162 0.147 0.188 0.500 0.062
15 OppenheimerFunds 0.637 0.067 0.167 0.064 0.179 0.000 0.017
16 MFS Investment Management 0.847 0.028 0.021 0.028 0.063 0.000 0.000
17 Columbia Management Group Inc. 0.735 0.056 0.549 0.229 0.472 0.250 0.133
18 Goldman Sachs Asset Management 0.800 0.000 0.357 0.283 0.500 0.135
19 Morgan Stanley Investment Advisors 0.467 0.100 0.288 0.074 0.283 0.250 0.027
20 American Express Financial Advisors 0.678 0.118 0.193 0.011 0.292 0.000 0.010
21 ING Investments LLC 0.708 0.227 0.049 0.006 0.105 0.000 0.024
22 Banc One Investment Advisors 0.538 0.600 0.376 0.234 0.179 0.180
23 JPMorgan Fleming Asset Management 0.833 0.571 0.400 0.158 0.300 1.000 0.200
24 T Rowe Price Associates Inc. 0.813 0.500 0.190 0.255 0.288 0.286 0.043
Mean Percentage Support 0.690 0.249 0.256 0.113 0.233 0.219 0.058
15
Fund Voting Behavior with Respect to Investment
Horizon
16
Table 4 Distribution of Shareholder Proposals
Voting Records Based on Fund Style
Table 4 Panel A Table 4 Panel A Table 4 Panel A Table 4 Panel A Table 4 Panel A Table 4 Panel A Table 4 Panel A
Fund Style Number of Funds Number of Voting Records Vote Cast for Vote Cast against Vote Cast abstain Vote Cast unknown
Value 39 6012 0.214 0.728 0.055 0.003
Growth 61 5641 0.173 0.760 0.066 0.000
Blend 41 8934 0.199 0.703 0.093 0.004
Balanced 16 2453 0.151 0.733 0.113 0.003
Others 71 5507 0.192 0.740 0.053 0.014
17
Research Questions

• Determinants of mutual funds voting policies
  across firms.
• Examine the incentive structure of mutual funds
  to undertake activist role in voting behavior.
• Investigate whether mutual funds engage in Wall
  Street Walk when dissatisfied with management.

18
Determinants of Voting Policies Across Firms

• Mutual funds voting pattern varies across firms
  for a particular proposal type
• Voting behavior is not influenced by the business
  ties (Davis and Kim (2005)
• Gordon and Pound (1993) examine the determinants
  of voting outcome of shareholders proposals
• We examine fund family voting behavior across
  firms and study whether voting is influenced by
• Family Characteristics
• Firm Characteristics and Performance
• Governance Structure of Firm
• Types of Proposals
• Ownership Structure of the Firm
• Dependent Variable Percentage of votes cast in
  support for shareholder proposal p of firm i by
  all funds in family f.

19
Table 6 Mean (Median) Percentage Support on
Shareholder Proposals in Extreme Portfolios
Based on Size, Book-to-Market and
Performance
Votes Cast as Support of Proposals Variable for Portfolio Construction P1 Mean (Median) P10 Mean (Median) P-value for difference (t-test for difference)
for FIRM SIZE 0.393 (0.125 0.154 (0.019) 0.0003 (0.18)
for BOOK TO MKT 0.451 (0.50) 0.336 (0.146) 0.14 (0.42)
for HISTORICAL LONG RUN EXCESS RETURN 0.423 (0.382) 0.330 (0.141) 0.25 (0.50)
for or abstain FIRM SIZE 0.480 (0.50) 0.213 (0.138) lt0.0001 (0.38)
for or abstain BOOK TO MKT 0.521 (0.520) 0.377 (0.268) 0.05 (0.03)
for or abstain HISTORICAL LONG RUN EXCESS RETURN 0.524 (0.50) 0.359 (0.20) 0.03 (0.24)
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Table 7 Mean (Median) Percentage Support on
Shareholder Proposals and Governance Indices
for as support of shareholder proposals for as support of shareholder proposals for as support of shareholder proposals for as support of shareholder proposals for as support of shareholder proposals
PROPOSAL TYPE GOVERNANCE INDEX High ATP Mean (Median) N Low ATP Mean (Median) N P-value for difference (t-test for difference)
All GIM 0.345 (0.148) 0.229 (0.019) 0.0001 (0.001)
All BCF 0.351 (0.143) 0.224 (0.040) lt0.0001 (0.001)
ANTITAKEOVER GIM 0.819 (0.875) 0.635 (0.694) 0.007 (0.004)
ANTITAKEOVER BCF 0.823 (0.875) 0.620 (0.6) 0.0002 (0.002)
VOTING ISSUES GIM 0.304 (0.021) 0.204 (0.154) 0.31 (0.32)
VOTING ISSUES BCF 0.240 (0.021) 0.238 (0.160) 0.98 (0.47)
SHAREHOLDER WEALTH AND RIGHTS GIM 0.285 (0.176) 0.235 (0.084) 0.35 (0.22)
SHAREHOLDER WEALTH AND RIGHTS BCF 0.252 (0.035) 0.273 (0.198) 0.69 (0.13)
EXECUTIVE COMPENSATION GIM 0.07 (0.0) 0.103 (0.0) 0.33 (0.22)
EXECUTIVE COMPENSATION BCF 0.041 (0.0) 0.110 (0.0) 0.03 (0.01)
DIRECTOR RELATED GIM 0.356 (0.333) 0.117 (0.0) 0.01 (0.008)
DIRECTOR RELATED BCF 0.266 (0.026) 0.179 (0.034) 0.35 (0.33)
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Table 8 Determinants of Voting Policies across
Firms Vote cast for Considered as Support
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Intercept 2.681 2.489 2.106 2.594 2.421 2.119
FAMILY SIZE -0.139 -0.139 -0.117 -0.133 -0.139 -0.117
BUSINESS TIES FAMILIES -0.055 -0.062 -0.084 -0.062 -0.073 -0.088
FIRM SIZE -0.089 -0.072 -0.055 -0.078 -0.057 -0.053
BOOK TO MKT -0.148 -0.120 -0.129 -0.164 -0.134 -0.135
HISTORICAL LONG RUN EXCESS RETURN 0.018 0.003 0.012 0.018 0.005 0.013
MAJOR STOCK LISTING 0.205 0.187 0.128 0.208 0.199 0.137
NUMBER OF PROPOSALS 0.005 0.005 0.006 0.004 0.005 0.005
GIM 0.019 0.021 0.008
BCF 0.039 0.047 0.012
DUAL CLASS -0.114 -0.041 -0.115 -0.041
PERCENT SHARE HOLD -0.446 -0.698 -0.393 -0.678
BLOCKHOLDER HOLD 0.002 0.001 0.002 0.001
INSIDER HOLD 0.003 0.002 0.002 0.002
ANTITAKEOVER 0.519 0.526
VOTING ISSUES 0.065 0.070
SHAREHOLDER WEALTH RIGHTS 0.049 0.057
EXECUTIVE COMPENSATION -0.071 -0.064
DIRECTOR RELATED 0.004 0.013
Family Fixed Effects YES YES YES YES YES YES
0.12 0.14 0.37 0.12 0.14 0.37
Number of Observations 5814 4395 4395 6133 4392 4392
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Effect of Voting Records Release on Funds
Reputation

• Whether there exist any direct reputational
  effect for undertaking activist role in voting
  mechanism
• Observe the next year funds asset flow after
  voting record release.
• Dependent variable Objective adjusted net asset
  flow of a fund over the next year of the mutual
  fund voting record release date.
• Independent variable Median percentage support
  by a fund over all shareholder proposals

23
Table 9 Effect of Mutual Funds Support of
Shareholder Proposals on Fund Flow
Model 1 Support Shareholder for Model 2 Support Shareholder for or abstain Model 3 Support Shareholder for Model 4 Support Shareholder for or abstain
Intercept -0.056 -0.051 -0.026 -0.018
MEDIAN PERCENT SUPPORT BY FUND 0.024 0.011 0.024 0.014
FUND SIZE 0.002 0.001 0.0008 -0.003
FAMILY SIZE 0.00001 0.00001 0.00001 0.00001
FUND AGE 0.003 0.003 0.004 0.004
FEE 0.020 0.022 0.006 0.006
SP STAR 0.003 0.003 0.002 0.002
OAR 0.117 0.113
4FACTOR ALPHA 0.196 0.227
PREV YEAR AVG NAF 0.285 0.293 0.294 0.294

Style Fixed Effects YES YES YES YES
0.47 0.46 0.47 0.47
Number of Observations 210 210 205 205
24
Mutual Funds Trading Behavior after Voting
Records Release

• Examine Whether mutual funds engage in Wall
  Street Walk when dissatisfied with management.
• Results Mutual funds sell off their shares when
  they provide higher support in shareholders
  proposals.
• Implications
• Mutual funds who support shareholders proposals
  are not very optimistic about the final outcome.
• When they dislike managements policy they engage
  in Wall Street Walk
• However, they undertake activist role before
  selling off their shares.

25
Table 10 Analysis of Mutual Fund Trading
Behavior after Voting Records Release
Model 1 Vote Cast for Model 2 Vote Cast for or abstain
Intercept 0.026 0.026
PERCENTGAE SUPPORT TO SHRHLD -0.016 -0.011
FIRM SIZE -0.004 -0.004
BOOK TO MKT -0.015 -0.015
EARNING-PRICE-RATIO 0.030 0.031
RETURN PAST 90 DAYS -0.036 -0.036
MAJOR STOCK LISTING 0.078 0.076
ALL INST HOLD -0.002 -0.003
PREV QTR PERC HOLD BY FUND -4.36 -4.36
BLOCKHOLDER HOLD 0.0001 0.0001
INSIDER HOLD -0.0003 -0.0003
GIM -0.0002 -0.0002
NUMBER OF PROPOSALS -0.0002 -0.0002
Family Fixed Effects YES YES
Fund Style Fixed Effects YES YES
0.07 0.07
Number of Observations 4873 4873
26
Conclusions

• Mutual funds undertake monitoring role
• For proposals that are likely to increase
  shareholders wealth and rights.
• In firms with weaker external monitoring
  mechanism
• In firms with entrenched management
• In firms where they are likely to have higher
  influence.
• Mutual funds experience a positive reputational
  effect for undertaking an activist role in their
  voting behavior
• If they disapprove managements policy they sell
  off their shares but before doing so they provide
  support to shareholders proposals.

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