Conflicts of Interest and Mutual Fund Proxy Voting: Evidence from Shareholder Proposals on Executive Compensation Rasha Ashraf Georgia State University Narayanan Jayaraman Georgia Institute of Technology Harley E. Ryan, Jr. Georgia State University For presentation at Harvard Law School: April 30, 2009 Our Research Question Do pension-related business ties between mutual funds and firms influence how mutual funds vote on shareholder executive compensation proposals? Why Shareholder Compensation Proposals? We do not presume that all compensation proposals are desirable or that firms that receive compensation proposals have poor compensation policies ISS (institutional Shareholder Services) supports only 44% of these proposals But, this sample provides a good laboratory to investigate potential conflicts of interest … Why Shareholder Compensation Proposals? These proposals potentially affect the economic welfare of the very people who have the power to influence who manages pension plans High profile corporate fraud and compensation abuses have focused public attention on compensation issues, which put these proposals in the limelight. Voter turnout compares to that for shareholder approvals of acquisitions, major corporate events that have a large impact on value DATA On a sample of 340 shareholder proposals on 171 firms for the year 2004-2006 Over 136,000 votes about 4,000 mutual funds (143 families) Voting Data Shareholder Proposals ISS Voting Analytics database compiled from SEC N-PX filings Form N-PX contains a brief identification of the matter voted on; • whether the matter was proposed by the issuer or a shareholder; • whether the fund voted on the matter and how the fund voted; • whether the fund voted for or against management. ISS also 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. ISS Support and Proposal Outcome ISS support is essential to the success of a proposal. All successful proposals are endorsed by ISS. However, not all proposals endorsed by ISS pass -- 37% of the proposals recommended by ISS fail. No proposal that receives an unfavorable ISS recommendation passes. ISS appears to favor proposals that target smaller firms that have experienced large growth in equity valuations and that have fewer outsiders on the board. Over 50% funds follow favorable ISS recommendations. Funds rarely support proposals when ISS recommends that the proposal be rejected. Mutual fund support appears to be important to the success of shareholder proposals. Mutual funds support 68% of the proposals that pass, but only 18% of the proposals that fail. Business Ties Data Business Ties Hand collected from ERISA form 5500 filings for pension plans • Trustee or service provider. • Fees paid to service provider (if disclosed) • Dollar value of interest in registered investment companies Aggregate across multiple plans ERISA 5500 form available for 166 firms of 171 sample firms. • Business ties firms: 119 (72% of the sample) • Non-business ties firms: 47 Business ties firms: larger, lower past 5 year stock return, higher CEO total compensation. Business Ties 60 fund families have business ties and 83 fund families have no business ties. 40% fund families have business ties. Business ties fund families tend to be larger than fund families without business ties. Average Number of Funds: Business Ties Families: 47 Non-business Ties Families: 17 Business ties fund families tend to be about 3 times larger than fund families without business ties. Results Mutual funds with pension-related business ties to a firm are more likely to vote with management and against shareholder proposals • Non-BT fund support 24% • BT fund support: 20% Moreover, mutual funds with business ties are more likely to vote against shareholder proposals when the proposal receives majority approval from other mutual funds or when ISS give favorable recommendation • Successful Proposals: • Non-BT family support 68% • BT family support: 47% • ISS support: • Non-BT family support 53% • BT family support: 39% Funds with business ties are more likely to support shareholders when ISS does not support the proposal and it is likely to fail Mutual Fund Vote: Effect of Business Ties Panel A: Percentage support for proposals by mutual funds Funds with Funds with p-value for no business ties business ties difference (Obs. = 130,081) (Obs. = 6,414) All proposals 24.3 20.1 0.00 Proposal passes 68.4 47.3 0.00 (Obs.= 16,369) Proposal fails 18.3 16.5 0.00 (Obs.= 120,126) ISS favorable recommendation 53.0 39.1 0.00 (Obs. = 57,565) ISS unfavorable recommendation 3.6 4.3 0.02 (Obs.= 78,930) ISS support matters Fees If the business tie results represent a conflict of interests, the fees earned by the fund should matter The larger the potential economic gain, the greater the potential for a conflict of interest We analyze the relation between mutual fund voting and fees earned by the fund families for the subsample of mutual funds for which we have fees Annual fees paid to mutual fund families for pension fund services range from as little as $1,083 to as much as $46.5 million. Among mutual funds with business ties, funds that receive larger fees are more likely to support management. Types of Proposals Different types of proposals could matter for at least two reasons Some proposals could impose greater costs on management than other proposals For all different types of proposals mutual funds with business ties are less likely to support shareholder proposals than are mutual funds without any pension-related business ties to the firm. Again, we find that this effect is greatest when ISS supports a proposal and the likelihood that it will pass increases. Effect of Business Ties on Types of Proposals Overall Results Mutual fund with pension-related business ties to the firm are more likely to vote with management on shareholder compensation proposals than are funds without business ties Suggests a potential conflict of interest Mutual funds with business ties are more likely to support management when ISS supports the proposal and more likely to vote for the shareholder proposal when ISS does not support the proposal Suggests a pattern of strategic voting by some mutual funds, possibly to give the appearance of activism or a focus on shareholder desire Contribution Suggests that disclosure of mutual fund proxy votes does not eliminate potential influence related to pension-plan business ties Possibly mitigated the problem, but this is impossible to test with publicly available data In the debate over executive compensation, it has been proposed that executive compensation be put to a shareholder vote. Our results raise some questions as to whether such votes would necessarily represent the will of the shareholders.