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

12. 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.

13. Management Name Total Number of Voting Records in Sample % Vote Cast “for” % Vote Cast “against” % Vote Cast “abstain” % Vote Cast “unknown” 1Fidelity Management Research 38440.1670.7050.1230.005 2Dreyfus Corporation 9710.1920.7840.0250.000 3Capital Research & Management Co. 22450.1810.7740.0090.036 4Deutsche Asset Management 24560.3210.6770.0020.000 5Vanguard Group Investment Co. 33500.1920.4840.3240.000 6Franklin Advisers Inc. 12900.1970.7590.0310.013 7Federated Investment Management Co 6230.0610.9340.0050.000 8AIM Advisors Inc. 13680.1850.6450.1670.002 9Smith Barney Asset Management 10040.2760.7130.0090.002 10Putnam Investment Mgmt LLC 14560.1580.8300.0110.001 11Alliance Capital Management Corp. 2900.2410.7100.0480.000 12Prudential Securities Incorporated 10550.2690.5720.1590.000 13Allianz Dresdner Asset Mgmt 4480.4670.5130.0200.000 14Merrill Lynch Investment Managers 8170.2060.7850.0100.000 15OppenheimerFunds 10270.1550.4720.3730.000 16MFS Investment Management 15870.1290.8580.0130.000 17Columbia Management Group Inc. 4020.3560.5820.0600.002 18Goldman Sachs Asset Management 780.2440.7560.000 19Morgan Stanley Investment Advisors 12130.1530.8380.0070.003 20American Express Financial Advisors 8690.1190.8730.0050.003 21ING Investments LLC 4600.1610.8170.0220.000 22Banc One Investment Advisors 4530.3020.6710.0260.000 23JPMorgan Fleming Asset Management 9700.3400.6600.000 24T Rowe Price Associates Inc. 14450.2410.7540.0010.005 Total Number of Proposals 297950.2210.7150.0600.003 Table 2: Descriptive Statistics of Sample Fund Family Voting

14. 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 Research0.7560.1120.2190.0870.1390.2240.007 2Dreyfus Corporation0.7700.0560.1720.0670.1110.2500.031 3Capital Research & Management Co.0.6800.5090.2440.0220.1190.1000.053 4Deutsche Asset Management0.8260.3210.5150.0830.3100.2000.080 5Vanguard Group Investment Co.0.6360.0410.2470.0170.0650.2940.056 6Franklin Advisers Inc.0.5590.4330.2820.1820.3850.3330.025 7Federated Investment Management0.4720.0210.000 8AIM Advisors Inc.0.6810.4500.1290.1100.2390.0920.056 9Smith Barney Asset Management0.7650.4060.3420.1220.2000.1430.090 10Putnam Investment Mgmt LLC0.8650.0530.0720.0090.1940.0000.008 11Alliance Capital Management Corp.0.5000.2500.3330.2550.2000.3330.059 12Prudential Securities Incorporated0.7860.4240.3160.1500.3770.7470.010 13Allianz Dresdner Asset Mgmt0.6480.3330.5120.1310.4170.2500.083 14Merrill Lynch Investment Managers0.5480.3080.1620.1470.1880.5000.062 15OppenheimerFunds0.6370.0670.1670.0640.1790.0000.017 16MFS Investment Management0.8470.0280.0210.0280.0630.000 17Columbia Management Group Inc.0.7350.0560.5490.2290.4720.2500.133 18Goldman Sachs Asset Management0.8000.0000.3570.2830.5000.135 19Morgan Stanley Investment Advisors0.4670.1000.2880.0740.2830.2500.027 20American Express Financial Advisors0.6780.1180.1930.0110.2920.0000.010 21ING Investments LLC0.7080.2270.0490.0060.1050.0000.024 22Banc One Investment Advisors0.5380.6000.3760.2340.1790.180 23JPMorgan Fleming Asset Management0.8330.5710.4000.1580.3001.0000.200 24T Rowe Price Associates Inc.0.8130.5000.1900.2550.2880.2860.043 Mean Percentage Support0.6900.2490.2560.1130.2330.2190.058

15. Fund Voting Behavior with Respect to Investment Horizon

16. 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 3960120.2140.7280.0550.003 Growth 6156410.1730.7600.0660.000 Blend 4189340.1990.7030.0930.004 Balanced 1624530.1510.7330.1130.003 Others71 5507 0.1920.7400.0530.014 Table 4: Distribution of Shareholder Proposals Voting Records Based on Fund Style

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. 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) BOOK TO MKT 0.451 (0.50) 0.336 (0.146) 0.14 (0.42) 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) <0.0001 (0.38) BOOK TO MKT 0.521 (0.520) 0.377 (0.268) 0.05 (0.03) HISTORICAL LONG RUN EXCESS RETURN 0.524 (0.50) 0.359 (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

20. “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) BCF 0.351 (0.143) 0.224 (0.040) <0.0001 (0.001) ANTITAKEOVER GIM 0.819 (0.875) 0.635 (0.694) 0.007 (0.004) 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) 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) 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) 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) BCF 0.266 (0.026) 0.179 (0.034) 0.35 (0.33) Table 7: Mean (Median) Percentage Support on Shareholder Proposals and Governance Indices

21. Model 1Model 2Model 3Model 4Model 5Model 6 Intercept2.6812.4892.1062.5942.4212.119 FAMILY SIZE-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 ***0.0030.012 **0.018 ***0.0050.013 ** MAJOR STOCK LISTING0.205 ***0.187 ***0.128 **0.208 ***0.199 ***0.137 ** NUMBER OF PROPOSALS0.005 *** 0.006 ***0.004 ***0.005 *** GIM0.019 ***0.021 ***0.008 *** BCF0.039 ***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 HOLD0.002 ***0.0010.002 ***0.001 * INSIDER HOLD0.003 ***0.002 *** ANTITAKEOVER0.519 ***0.526 *** VOTING ISSUES0.065 *0.070 ** SHAREHOLDER WEALTH RIGHTS0.0490.057 * EXECUTIVE COMPENSATION-0.071 **-0.064 ** DIRECTOR RELATED0.0040.013 Family Fixed EffectsYES 0.120.140.370.120.140.37 Number of Observations58144395 61334392 Table 8: Determinants of Voting Policies across Firms : Vote cast “for” Considered as Support

22. 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. 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 SIZE0.0020.0010.0008-0.003 FAMILY SIZE0.00001 FUND AGE0.003 0.0040.004 * FEE0.0200.0220.006 S&P STAR0.003 0.002 OAR0.117 **0.113 * 4FACTOR ALPHA0.196 **0.227 *** PREV YEAR AVG NAF0.285 ***0.293 ***0.294 *** Style Fixed EffectsYES 0.470.460.47 Number of Observations210 205 Table 9: Effect of Mutual Funds’ Support of Shareholder Proposals on Fund Flow

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. Model 1: Vote Cast: “for” Model 2: Vote Cast: “for” or “abstain” Intercept 0.026 PERCENTGAE SUPPORT TO SHRHLD -0.016 ***-0.011 ** FIRM SIZE -0.004 ** BOOK TO MKT -0.015 ** EARNING-PRICE-RATIO 0.0300.031 RETURN PAST 90 DAYS -0.036 *** MAJOR STOCK LISTING 0.078 ***0.076 *** ALL INST HOLD -0.002-0.003 PREV QTR PERC HOLD BY FUND -4.36 *** BLOCKHOLDER HOLD 0.0001 INSIDER HOLD -0.0003 GIM -0.0002 NUMBER OF PROPOSALS -0.0002 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

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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