An Empirical Examination of Mutual Fund Boards

Abstract

Agency conflicts between mutual fund investors and fund sponsors have recently received close attention from regulators and legislators. In response to improprieties regarding pricing calculations and trading deadlines, the Securities and Exchange Commission has adopted a controversial new rule requiring fund boards to have at least 75% independent directors and an independent chair person. This study examines to what extend board independence and director incentives in the mutual fund industry are systematically related to fund expenses, performance, and compliance. It is based on a novel panel dataset that covers about 60% of assets listed in the CRSP mutual fund database over the period from 1995 through 2004. The study finds that funds overseen by an independent chair charge lower fees, while the relation between fund fees and the fraction of independent directors varies through time. Both measures of board independence do not affect fund performance in an economically significant way. Funds with higher director ownership and lower unexplained compensation charge lower fees and deliver higher returns. These empirical findings are consistent with both the watchdog hypothesis, stating that greater independence and better incentive alignment causes boards to bargain harder with fund advisors, which results in lower fees, and the clientele hypothesis, suggesting that some sponsors strive to attract assets from relatively sophisticated investors who are concerned about conflicts of interest and sensitive to expenses. When attempting to empirically distinguish between these competing hypotheses, I find that boards with an independent chair negotiate lower total expenses, but approve higher management fees and that they do not have a lower probability of being subject to litigation by regulators and shareholders. In light of these results, this study finds only limited empirical support for recent initiatives to regulate mutual fund board structure.