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The Party Structure of Mutual Funds

Journal: Review of Financial Studies

Date: 20220601

Author: Bubb, Ryan; Catan, Emiliano M.

Abstract:
We investigate the structure of mutual funds' corporate governance preferences as revealed by how they vote their shares in portfolio companies. We apply unsupervised learning tools from the machine learning literature to analyze mutual funds' votes and find that a parsimonious two-dimensional model can explain the bulk of mutual fund voting. The dimensions capture competing visions of corporate governance and are related to the leading proxy advisors' recommendations. Cluster analysis shows that mutual funds are organized into three "parties"--the Traditional Governance Party, Shareholder Reform Party, and Shareholder Protest Party--that follow distinctive philosophies of corporate governance and shareholders' role.

Link: Google Scholar

Key Findings

Three Distinct Mutual Fund Parties

Mutual funds cluster into three distinct "parties" with different corporate governance philosophies: Traditional Governance Party, Shareholder Reform Party, and Shareholder Protest Party

Party Characteristics

Each party has distinctive voting patterns and approaches to corporate governance, with the Traditional Governance Party being the largest by assets but most deferential to management

Compliance Approach Impact

Investment advisors' approach to voting compliance strongly influences party membership, particularly for passive advisors

Party Size and Composition

  • Traditional Governance Party dominates with 66% of total assets
  • Shareholder Reform and Protest parties each control ~6-7% of assets
  • Size distribution shows concentration of voting power in Traditional Governance Party

Management Support by Party

  • Traditional Governance Party shows more balanced support across categories
  • Shareholder Reform Party exhibits highest overall management support
  • Shareholder Protest Party shows most variation in support levels

Compliance Approach Impact on Party Membership

  • Only 6.5% of Traditional Governance Party members take compliance approach
  • 41% of Shareholder Reform Party members use compliance approach
  • 30% of Shareholder Protest Party members follow compliance approach

Contribution and Implications

  • First systematic characterization of mutual funds' corporate governance preferences using machine learning techniques
  • Reveals how investment advisors' incentives and approach to compliance influence voting behavior
  • Provides framework for understanding voting patterns in corporate governance
  • Highlights potential concerns about "compliance-based" approach to voting, especially among passive advisors

Data Sources

  • Party composition chart based on Table 10 fund characteristics by party
  • Management support visualization derived from Table 4 fraction of votes cast in party's minority
  • Compliance approach impact chart constructed using compliance approach data from Table 10