Mutual Fund Soft Dollar Arrangements: Determinants and the Effect on Shareholders

Abstract

Mutual fund advisers determine the scope of brokerage services, broker participation, and whether to self-produce or outsource brokerage services through soft dollar arrangements. In return for the outsourced research, fund shareholders may expect to benefit from better performance and a reduction in the advisory fee. This study is the first one that (i) uses actual (not estimated) soft dollar fee amounts, and (ii) examines soft dollar arrangements in the context of mutual fund governance. We analyze soft dollar arrangements using a unique survivorship bias-free hand-collected data set of 432 U.S.-based equity funds managed by 129 different advisers. We find that higher soft dollar commissions are associated with lower risk-adjusted performance and higher advisory fees. That is, shareholders’ wealth is adversely affected by the cost of soft dollar arrangements. While we cannot rule out that at least some research paid for with soft dollars is superior, research quality is likely not homogenous, and the cost of obtaining it on average appears to outweigh the benefits. Larger boards are associated with lower advisory fees. At the same time, funds that have boards with higher proportions of members with finance occupations and more highly compensated boards (the variables usually associated with higher board quality) tend to pay higher soft dollar fees. This result may be indicative of the alignment of board members’ interest with those of the fund management.