Protectionist mutual funds

Abstract

A diversified shareholder has no interest in a policy like trade protection which may help some firms, but only at the expense of harming other firms in the portfolio. There is some evidence, and substantial sentiment, in support of the view that trade protection indeed has a deleterious effect overall on business and economy-wide growth. Indeed, it would surprise most investors if a mutual fund like Fidelity or Vanguard suddenly called out for increased trade barriers. But this then raises the question as to why managers of firms seem to pursue policies such as protection which are probably not in the overall interests of the diversified owners of the firms. One potential contributing factor, explored in this paper, resides in how shareholders resolve a multi-task principal-agent problem which poses a dilemma for diversified owners of firms. On the one hand, when a manager's performance is imperfectly observable, it may well be in the shareholders' interests to tie the manager's remuneration to the firm's performance. Thus, the manager can be induced to ‘work’ instead of ‘shirk’. But, once the manager is so tied to the firm's performance, he may acquire an interest not only in working, but also in appealing to the political process for protection which is beneficial to his industry while harmful to capital's overall performance. If such ‘lobbying’ is itself subtle or difficult to observe, then shareholders confront the dilemma that in trying to solve the work-shirk problem there are now also incentives created for the manager to pursue policies which are harmful to other firms in the shareholders' portfolios. This paper explores the implications of this dilemma.