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«Abstract We examine the relation between mutual fund votes on shareholder executive compensation proposals and pension-related business ties between ...»

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

Evidence from Shareholder Proposals on Executive Compensation

Rasha Ashraf,a Narayanan Jayaraman,b Harley E. Ryan, Jr.a,*


J. Mack Robinson College of Business, Georgia State University,

Atlanta, GA 30303, USA


Georgia Institute of Technology, Atlanta, GA, 30308, USA

November 23, 2010


We examine the relation between mutual fund votes on shareholder executive compensation

proposals and pension-related business ties between fund families and the firms. In unconditional tests, we find that fund families support management when they have pension ties to the firm.

We find no relation when we stratify by fund family in conditional tests, which suggests that fund families with pension ties vote with management at both client and non-client firms. We confirm this result in an analysis of non-client firms. Overall, our results suggest that pension-related business ties influence fund families to vote with management at all firms.

JEL classification: G30; G23 Keywords: Proxy Voting, Mutual Funds, Executive Compensation, Shareholder Rights We thank the editor, an anonymous referee, Vikas Agarwal, Anup Agrawal, Daniel Chi, Jonathan Clarke, Brandon Cline, Cheol Eun, Gerry Gay, Lixin Huang, Omesh Kini, Junsoo Lee, James Ligon, Reza Mahani, Shawn Mobbs, Angela Morgan, Vikram Nanda, Laura Starks, Isabel Tkatch, Qinghai Wang, Jack Wolf, Tina Yang, and seminar participants at Clemson University, Georgia State University, Georgia Tech, the University of Alabama, and the 2009 Financial Management Association Meetings in Reno, Nevada for helpful comments. We also thank

Larry Beeferman, Randy Barber, Richard Ferlauto, Gerald Davis, Jennifer Taub, and participants of Capital Matters:

Managing Labor’s Capital Conference 2009 at Harvard Law School for their insightful discussion and comments.

We appreciate the excellent research assistance of Zinat Alam, Djibril Dieng, Daniel Greene, and Hyung Suk Choi.

The authors assume responsibility for any errors. Comments are welcome.

*Author contact information: Department of Finance, J. Mack Robinson College of Business, Georgia State University, Atlanta, GA 30303, USA. Tel.: +1-404-413-7337; fax: +1-404-413-7312.

E-mail: cryan@gsu.edu (H. E. Ryan) Electronic copy available at: http://ssrn.com/abstract=1351966 Do Pension-Related Business Ties Influence Mutual Fund Proxy Voting?

Evidence from Shareholder Proposals on Executive Compensation I. Introduction The ability to propose governance reforms in corporate proxy votes allows shareholders to mitigate agency problems in publicly held firms. Mutual funds play a critical role in proxy votes and they use their voting power to protect the interests of fund investors. According to reports in the popular press, however, potential conflicts of interest related to the management of firm retirement plans lead mutual funds to nearly always oppose shareholder proposals, particularly when proposals concern executive compensation.1 Conversely, the economic costs of reputation loss or possible lawsuits against the fund family may offset any short-term benefits of such voting. In view of these charges in the popular press and the associated economic tradeoffs, we seek to answer the following empirical question: Do pension-related business ties influence mutual fund votes on shareholder-sponsored executive compensation proposals?

The empirical evidence on whether pension-related business ties between mutual funds and firms create conflicts of interest is limited. Davis and Kim (2007) find that fund families with the most pension-related business ties tend to vote with management in the aggregate, but do not document an influence at the firm-proposal level. These results lead these authors to surmise that “A mutual fund company with heavy business ties may adopt voting policies and guidelines that lead to fewer votes against management across all portfolio firms, thereby reducing the risk of alienating the management of client firms” (page 569).2 Although this See “Do Mutual Funds Back CEO Pay?—Study Finds Firms Failed to Use Voting Power in Favor of Linking Compensation to Performance” (The Wall Street Journal, March 28, 2006).

See also Cohen and Schmidt (2009), who find that fund families receive large inflows when they are trustees of retirement plans, which is a substantial benefit in addition to the direct fees that the fund families receive. Moreover, these authors find that fund families overweight in their portfolios the stocks of firms for whom they are pension trustees, which suggests the possibility of a quid pro quo arrangement.

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interpretation suggests a fund-family fixed effect, the data in Davis and Kim (2007) are limited to institutions with pension business and do not allow for a rigorous test of such influence.

We examine the association between pension-related business ties and fund-family votes on 340 shareholder-sponsored executive compensation proposals over the period January, 2004– June, 2006. We believe that executive compensation proposals provide a sharply delineated test of conflicts of interest, since such proposals directly influence the economic welfare of the executives who determine which institutions manage their pension funds. Our analysis of nearly 18,000 votes cast by 143 fund families, 67 with pension-related business ties and 76 without ties, documents a strong relation between the likelihood that a fund family votes against shareholder proposals on compensation and pension-related business ties. Consistent with a conflict of interest, such result is prevalent only when Institutional Shareholder Services (ISS) recommends passage of a proposal. Inclusion of fund-family fixed effects and analysis of voting behavior by fund families with pension ties at non-client firms, reveals that fund families tend to vote with management at all firms, possibly to maintain reputation and to minimize the potential for lawsuits.

Our results extend the findings of Davis and Kim (2007) to the firm proposal level and confirm their intuition that fund families with business ties vote with management at all firms.

As such, our findings contribute to understanding institutional investor voting behavior (see also Gillan and Starks, 2000; Parrino, Sias, and Starks, 2003). Our findings also complement the evidence set forth in Cohen and Schmidt (2009), who find that trustees of pension funds receive increased fund flows from clients and overweight client firms in the portfolio, which suggests the potential for an implicit quid pro quo arrangement. Our results, along with those of Davis and Kim (2007), indicate that such influence extends beyond portfolio choice and affects how fund families vote on shareholder proposals. Brickley, Lease, and Smith (1988, 1994) find that “pressure-resistant” institutions such as mutual funds are more likely to vote against management on anti-takeover amendments. Our findings imply that fund families with pension-related ties are less insulated from management pressures than are fund families without ties.

The remainder of this paper is organized as follows. Section II presents a discussion of the economic influences on fund-family voting, along with our main hypotheses. Section III describes our sample and data. Section IV presents the main results of our analysis. Finally, Section V describes our conclusions.

II. Conceptual Development and Hypotheses Brickley et al. (1988, 1994) investigate institutional voting on proposals initiated by management for adopting anti-takeover provisions. These authors argue that non-bank trusts, insurance companies, and commercial banks generally have current or potential business with corporations and are therefore more likely to be pressured by management to provide support on controversial issues. In contrast, public pension funds, mutual funds, and foundations are less influenced by management pressure and more readily oppose management on controversial issues. They conclude that pressure-resistant institutions, such as mutual funds, are more likely to oppose management than are pressure-sensitive institutions, such as banks, insurance companies,

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However, fund families that manage pension funds for corporate clients receive significant economic benefits in the form of direct fees, increased assets under management, and fund flows (Davis and Kim, 2007; Cohen and Schmidt, 2009). These financial gains provide an incentive to vote with management on proxy votes so as not to jeopardize these valuable business relationships. When the Securities and Exchange Commission (SEC) voted to require mutual funds to disclose their votes on proxy proposals, SEC Chairman Harvey Pitt stated that conflicts of interest related to mutual fund management of pension funds was a key factor that led him to push for the disclosure rule.3 Even with the increased disclosure, subsequent empirical evidence on proxy voting (Davis and Kim, 2007) and portfolio allocation (Cohen and Schmidt,

2009) suggests that conflicts of interest persist.

An alternative theoretical approach suggests that large shareholders have incentives to increase the value of their portfolios (which would attract greater fund flows and result in larger management fees) through shareholder activism (e.g., Shleifer and Vishny, 1986). Nevertheless, the literature suggests that most institutions, particularly mutual funds, frequently refrain from shareholder activism and “vote with their feet” by selling shares if they cannot support management (see Roe, 1990; Bhide, 1993; and Parrino, Sias and Starks, 2003). Thus, given the general tendency of mutual funds to support management and the additional incentives to appease management faced by mutual funds with pension-related ties, we expect mutual funds that manage pension funds to be more likely to oppose shareholder proposals on executive compensation at client firms.

The general tendency of mutual funds to support management can make it difficult to detect conflicts of interest in a cross-sectional test. Evidence suggests, however, that institutions frequently follow ISS voting recommendations and that ISS recommendations unfavorable to management decrease institutional support for management (Bethel and Gillan, 2002). The influence of ISS recommendations is not trivial. For instance, Bethel and Gillan find that an See “Mutual Funds Face Rule on Disclosure; SEC Vote on Proxies Rebuffs the Industry” (The Washington Post, January 24, 2003).

unfavorable ISS recommendation is associated with 13.6% to 20.6% fewer votes cast in favor of management. Similarly, Cai, Garner, and Walkling (2009) report that in director elections, directors who receive a negative ISS recommendation obtain 19% fewer votes. Because of their incentives to avoid alienating management, we expect that fund families with pension-related ties are less influenced by ISS recommendations than are fund families without pension-related ties. Thus, our second testable hypothesis is that the influence of pension-related ties on mutual fund voting will be most apparent when ISS recommends in favor of a proposal.

SEC regulations mandate disclosure of complete fund proxy voting records as of July 1,

2003. Given this increased transparency, fund families can develop a reputation of voting with management, which can harm their reputations with retail investors. Moreover, an obvious pattern of voting that reflects a conflict of interest could increase the likelihood of lawsuits from the SEC or activist state officials. These issues lead Davis and Kim (2007) to propose that fund families with pension-related business ties have an incentive to vote with management at client and non-client firms alike, to avoid the appearance of partiality.

Fund families could follow an alternative strategy of not voting or formally abstaining when a vote for management at a client firm could be construed to be contrary to shareholder objectives. However, mutual funds have a fiduciary responsibility to vote on behalf of and in the interests of their clients. A strategy of not voting, therefore, would not necessarily result in diminished reputational losses or lower the risk of lawsuits. Moreover, both “no votes” and formal abstentions must be disclosed under SEC regulations. In practice, both actions would have a similar connotation of voting against management and could jeopardize the relationship with management at client firms. Following a pro-management agenda across all client firms would appear to be a more plausible strategy.

Based on these arguments, we expect that mutual funds with pension-related business ties will likely support management at both client and non-client firms, as predicted by Davis and Kim (2007). Econometrically, such a policy suggests a fund-family fixed effect, which leads to a testable hypothesis: we expect no relation between support for shareholder proposals on compensation and pension-related business ties after controlling for fund-family fixed effects.

III. Sample and Data A. Shareholder Proposals and Mutual Fund Voting Data We obtain a sample of shareholder proposals on executive compensation, along with mutual fund voting data on these proposals from the ISS Voting Analytics database, which compiles voting records from SEC N-PX filings. The ISS database contains mutual fund voting records and aggregate votes on proposals. The proxy voting disclosure rule implemented by the SEC in January 2003 requires mutual funds to disclose their proxy voting records on portfolio shares annually by August 31 of each year, on Form N-PX. Form N-PX includes the name of the issuer of the portfolio security, the exchange ticker symbol and CUSIP number of the security, the shareholder meeting date, a brief description of the proposal, whether the matter was proposed by the issuer or by a shareholder, whether the fund voted, and how the fund voted.

We have access to ISS data on proxy votes from January 2004 through June 2006. In addition to voting records, ISS provides the ISS recommendation for the proposal, the total number of shares outstanding, the total number of shares voted for the proposal, and outcome of the proposal. Our sample comprises 340 shareholder-sponsored executive compensation–related proposals received by 171 firms over the sample period January, 2004–June 2006. We analyze nearly 18,000 votes by 143 fund families.

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