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

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

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

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.

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.”

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.

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

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)

Data Proxy voting records in shareholders’ proposals for the period July 1, 2003 to June 30, 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 mutual funds Over 29,000 observations covering 528 firms.

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

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

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 company’s 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.

Management Name Total Number of Voting Records in Sample % Vote Cast “for” % Vote Cast “against” % Vote Cast “abstain” % Vote Cast “unknown” 1Fidelity Management Research Dreyfus Corporation Capital Research & Management Co Deutsche Asset Management Vanguard Group Investment Co Franklin Advisers Inc Federated Investment Management Co AIM Advisors Inc Smith Barney Asset Management Putnam Investment Mgmt LLC Alliance Capital Management Corp Prudential Securities Incorporated Allianz Dresdner Asset Mgmt Merrill Lynch Investment Managers OppenheimerFunds MFS Investment Management Columbia Management Group Inc Goldman Sachs Asset Management Morgan Stanley Investment Advisors American Express Financial Advisors ING Investments LLC Banc One Investment Advisors JPMorgan Fleming Asset Management T Rowe Price Associates Inc Total Number of Proposals Table 2: Descriptive Statistics of Sample Fund Family Voting

Table 3: Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families Management NameANTITAKEOVER VOTING ISSUES SHAREHOLDER WEALTH AND RIGHTS EXECUTIVE COMPENSATION DIRECTOR RELATED AUDITOTHERS 1Fidelity Management Research Dreyfus Corporation Capital Research & Management Co Deutsche Asset Management Vanguard Group Investment Co Franklin Advisers Inc Federated Investment Management AIM Advisors Inc Smith Barney Asset Management Putnam Investment Mgmt LLC Alliance Capital Management Corp Prudential Securities Incorporated Allianz Dresdner Asset Mgmt Merrill Lynch Investment Managers OppenheimerFunds MFS Investment Management Columbia Management Group Inc Goldman Sachs Asset Management Morgan Stanley Investment Advisors American Express Financial Advisors ING Investments LLC Banc One Investment Advisors JPMorgan Fleming Asset Management T Rowe Price Associates Inc Mean Percentage Support

Fund Voting Behavior with Respect to Investment Horizon

Table 4: Panel A Fund StyleNumber of Funds Number of Voting Records % Vote Cast “for” % Vote Cast “against” % Vote Cast “abstain” % Vote Cast “unknown” Value Growth Blend Balanced Others Table 4: Distribution of Shareholder Proposals Voting Records Based on Fund Style

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.

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.

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 ( (0.019) (0.18) BOOK TO MKT (0.50) (0.146) 0.14 (0.42) HISTORICAL LONG RUN EXCESS RETURN (0.382) (0.141) 0.25 (0.50) “for” or “abstain” FIRM SIZE (0.50) (0.138) < (0.38) BOOK TO MKT (0.520) (0.268) 0.05 (0.03) HISTORICAL LONG RUN EXCESS RETURN (0.50) (0.20) 0.03 (0.24) Table 6: Mean (Median) Percentage Support on Shareholder Proposals in Extreme Portfolios Based on Size, Book-to-Market and Performance

“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 (0.148) (0.019) (0.001) BCF (0.143) (0.040) < (0.001) ANTITAKEOVER GIM (0.875) (0.694) (0.004) BCF (0.875) (0.6) (0.002) VOTING ISSUES GIM (0.021) (0.154) 0.31 (0.32) BCF (0.021) (0.160) 0.98 (0.47) SHAREHOLDER WEALTH AND RIGHTS GIM (0.176) (0.084) 0.35 (0.22) BCF (0.035) (0.198) 0.69 (0.13) EXECUTIVE COMPENSATION GIM 0.07 (0.0) (0.0) 0.33 (0.22) BCF (0.0) (0.0) 0.03 (0.01) DIRECTOR RELATED GIM (0.333) (0.0) 0.01 (0.008) BCF (0.026) (0.034) 0.35 (0.33) Table 7: Mean (Median) Percentage Support on Shareholder Proposals and Governance Indices

Model 1Model 2Model 3Model 4Model 5Model 6 Intercept FAMILY SIZE *** *** *** *** *** BUSINESS TIES FAMILIES * * *** ** ** *** FIRM SIZE *** *** *** *** *** *** BOOK TO MKT *** *** *** *** *** *** HISTORICAL LONG RUN EXCESS RETURN *** **0.018 *** ** MAJOR STOCK LISTING0.205 ***0.187 ***0.128 **0.208 ***0.199 ***0.137 ** NUMBER OF PROPOSALS0.005 *** ***0.004 ***0.005 *** GIM0.019 ***0.021 ***0.008 *** BCF0.039 ***0.047 ***0.012 ** DUAL CLASS *** * *** * PERCENT SHARE HOLD ** ** BLOCKHOLDER HOLD0.002 *** ***0.001 * INSIDER HOLD0.003 ***0.002 *** ANTITAKEOVER0.519 ***0.526 *** VOTING ISSUES0.065 *0.070 ** SHAREHOLDER WEALTH RIGHTS * EXECUTIVE COMPENSATION ** ** DIRECTOR RELATED Family Fixed EffectsYES Number of Observations Table 8: Determinants of Voting Policies across Firms : Vote cast “for” Considered as Support

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

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 MEDIAN PERCENT SUPPORT BY FUND **0.011 *0.024 **0.014 ** FUND SIZE FAMILY SIZE FUND AGE * FEE S&P STAR OAR0.117 **0.113 * 4FACTOR ALPHA0.196 **0.227 *** PREV YEAR AVG NAF0.285 ***0.293 ***0.294 *** Style Fixed EffectsYES Number of Observations Table 9: Effect of Mutual Funds’ Support of Shareholder Proposals on Fund Flow

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.

Model 1: Vote Cast: “for” Model 2: Vote Cast: “for” or “abstain” Intercept PERCENTGAE SUPPORT TO SHRHLD *** ** FIRM SIZE ** BOOK TO MKT ** EARNING-PRICE-RATIO RETURN PAST 90 DAYS *** MAJOR STOCK LISTING ***0.076 *** ALL INST HOLD PREV QTR PERC HOLD BY FUND *** BLOCKHOLDER HOLD INSIDER HOLD GIM NUMBER OF PROPOSALS Family Fixed Effects YES Fund Style Fixed Effects YES 0.07 Number of Observations 4873 Table 10: Analysis of Mutual Fund Trading Behavior after Voting Records Release

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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