Customers as Friendly Shareholders: Uncovering the Complex Mutual Fund-Broker Relationship

Abstract

This paper examines mutual funds’ dual role as both clients and shareholders of broker banks. Mutual funds are more likely to hold and significantly overweight stocks of their broker banks. In line with the portfolio decisions, fund voting is biased toward broker management in contentious proposals. Such voting bias is inconsistent with maximizing broker banks’ shareholder value yet significantly affects voting outcomes and the presence of contentious proposals at the banks’ shareholder meetings. Furthermore, we show that although client funds are rewarded with preferential initial public offering allocations from connected brokers for their voting support, fund managers’ engagement in reciprocal practices is ultimately determined by the economic tradeoffs they face. Our study not only uncovers a new mechanism—being brokers’ friendly shareholders—through which the two parties maintain their quid pro quo relationships but also raises a broader concern about governance of important financial institutions. This paper was accepted by Victoria Ivashina, finance. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4820 .