Determinants and Consequences of Proxy Voting by Mutual Funds on

Shareholder Proposals

Rasha Ashraf

Narayanan Jayaraman

December 13, 2006

Motivation

An important corporate governance mechanism is voting rights of shareholders

Institutional investors take the responsibility to vote on behalf of individual investors.

Institutional investors hold 66% of U.S. stocks.

Total assets of mutual funds 1950 : $2 billion 2006 : $10 trillion

Motivation With more than 25% of all U.S. stocks under their

control, mutual funds could practically run the business world, working with other large investors to throw out overpaid CEOs and force corporate overhauls. But they don't.

WSJ, October 3, 2006

Fidelity holds a 10% or greater stake in at least 100 of the nation's largest 1,000 companies and, controls at least $1.3 trillion, more than all hedge funds combined. But Fidelity rarely exercises its unprecedented muscle to push for improved corporate governance.

Business Week, October 16, 2006

Objective

Study the determinants of mutual funds’ voting policies across firms.

Examine the incentive structure of mutual funds to undertake activist role in voting behavior.

Investigate whether mutual funds engage in “Wall Street Walk” when dissatisfied with management.

In 2002 SEC Reports: “Traditionally mutual funds have been viewed as largely

passive investors, reluctant to challenge corporate management on issues such as corporate governance. Funds have often followed the so called “Wall Street Rule” according to which an investor should either vote as management recommends or if dissatisfied with management, sell the stock.”

History of Mutual Funds Disclosure Policy

In December 2000: SEC started to examine the proxy vote disclosure issue for mutual funds

In September, 2002: SEC propose to consider requiring mutual funds to disclose their proxy voting policies and actual votes cast.

There was unanimous opposition by the mutual funds on this proposal.

In January, 2003: SEC adopt new rule which made disclosure of proxy voting policies and procedures mandatory

File new Form N-PX, containing proxy voting records for the 12-month period ended June 30 by no later than August 31 of each year.

Literature: Mutual Funds’ Voting Behavior

Rothberg and Lilien (2005): analysis of the largest 10 fund families’ proxy voting policies.

Davis and Kim (2005): conflict of interests of mutual funds in their voting behavior

Shareholder Proposals and Shareholder Activism

Survey: Gillan & Starks (1998) Karpoff (2001) Black (1998) Romano (2001)

Other Studies: Karpoff, Maletesta, & Walking (1996) Ertimur, Ferri and Stubben (2005)

Data Proxy voting records in shareholders’ proposals for the period July 1, 2003 to

June 30, 2004. Proxy voting record in Form N-PX would include

Identification of the company and the proposal

Sponsor of the proposal: management or shareholder

Whether the fund voted on the proposal or not.

How the fund voted: “for” “against” “abstain” “unknown”

Whether the fund voted for or against management: “for” “against” “unknown”

24 biggest fund families based on the total net assets for the year 2004.

433 mutual funds

Over 29,000 observations covering 528 firms.

Data

CRSP mutual fund database: fund performance and characteristic data

Thomson Financial Mutual Fund Holding Database: mutual fund holdings data.

CDA-Spectrum 13-f filings: Mutual fund families’ holdings data

CRSP: Returns, share outstanding and market capitalization

COMPUSTAT: firms’ earnings data

Compact Disclosure SEC data source: Blockholder and insider holdings data

Gompers-Ishii-Metrick governance score data

Types of Shareholder Proposals

Total 74 types of shareholder proposals

Seven broad categories Anti-takeover Voting Issues Shareholder Wealth and Rights Executive Compensation Director Related Audit Committee Other Social and Ethical Issues

Anti-takeover

1. Supermajority Provision: Shareholder vote requirements are higher than the minimum levels set by state law to approve a merger or other business combination.

2. Poison Pill: Shareholders are issued rights to purchase stock in their own company or in the acquiring company at a steep discount if a hostile bidder acquires company’s shares.

3. Classify Board: It is also known as staggered board. The board is divided into classes, with the directors in each class serving overlapping terms.

4. Golden Parachutes: A contract specifying that executive will receive large benefits in the event that the company is acquired and the executive's employment is terminated.

5. Opt Out of State Takeover Statute: Most state anti-takeover provisions allow companies to "opt in" or to "opt out" of coverage by stating their intention in their charters.

Management NameTotal Number of

Voting Records in Sample

% Vote Cast

“for”

% Vote Cas

t“against”

% Vote Cast

“abstain”

% Vote Cast“unknown”

1 Fidelity Management Research 3844 0.167 0.705 0.123 0.005

2 Dreyfus Corporation 971 0.192 0.784 0.025 0.000

3Capital Research &

Management Co. 2245 0.181 0.774 0.009 0.036

4 Deutsche Asset Management 2456 0.321 0.677 0.002 0.000

5 Vanguard Group Investment Co. 3350 0.192 0.484 0.324 0.000

6 Franklin Advisers Inc. 1290 0.197 0.759 0.031 0.013

7Federated Investment

Management Co 623 0.061 0.934 0.005 0.000

8 AIM Advisors Inc. 1368 0.185 0.645 0.167 0.002

9Smith Barney Asset

Management 1004 0.276 0.713 0.009 0.002

10 Putnam Investment Mgmt LLC 1456 0.158 0.830 0.011 0.001

11Alliance Capital Management

Corp. 290 0.241 0.710 0.048 0.000

12Prudential Securities

Incorporated 1055 0.269 0.572 0.159 0.000

13 Allianz Dresdner Asset Mgmt 448 0.467 0.513 0.020 0.000

14Merrill Lynch Investment

Managers 817 0.206 0.785 0.010 0.000

15 OppenheimerFunds 1027 0.155 0.472 0.373 0.000

16 MFS Investment Management 1587 0.129 0.858 0.013 0.000

17Columbia Management Group

Inc. 402 0.356 0.582 0.060 0.002

18Goldman Sachs Asset

Management 78 0.244 0.756 0.000 0.000

19Morgan Stanley Investment

Advisors 1213 0.153 0.838 0.007 0.003

20American Express Financial

Advisors 869 0.119 0.873 0.005 0.003

21 ING Investments LLC 460 0.161 0.817 0.022 0.000

22 Banc One Investment Advisors 453 0.302 0.671 0.026 0.000

23JPMorgan Fleming Asset

Management 970 0.340 0.660 0.000 0.000

24 T Rowe Price Associates Inc. 1445 0.241 0.754 0.001 0.005

Total Number of Proposals 29795 0.221 0.715 0.060 0.003

Table 2: Descriptive Statistics of Sample Fund Family Voting

Table 3: Percentage of Vote in Support for Different Types of Shareholder Proposals by Fund Families

Management NameANTITAKEOVE

RVOTING ISSUES

SHAREHOLDER WEALTH AND

RIGHTS

EXECUTIVE COMPENSATIO

N

DIRECTOR

RELATEDAUDIT

OTHERS

1Fidelity Management

Research0.756 0.112 0.219 0.087 0.139 0.224 0.007

2 Dreyfus Corporation 0.770 0.056 0.172 0.067 0.111 0.250 0.031

3Capital Research &

Management Co.0.680 0.509 0.244 0.022 0.119 0.100 0.053

4 Deutsche Asset Management 0.826 0.321 0.515 0.083 0.310 0.200 0.080

5Vanguard Group Investment

Co.0.636 0.041 0.247 0.017 0.065 0.294 0.056

6 Franklin Advisers Inc. 0.559 0.433 0.282 0.182 0.385 0.333 0.025

7Federated Investment

Management 0.472 0.021 0.000 0.000 0.000 0.000 0.000

8 AIM Advisors Inc. 0.681 0.450 0.129 0.110 0.239 0.092 0.056

9Smith Barney Asset

Management0.765 0.406 0.342 0.122 0.200 0.143 0.090

10Putnam Investment Mgmt

LLC0.865 0.053 0.072 0.009 0.194 0.000 0.008

11Alliance Capital Management

Corp.0.500 0.250 0.333 0.255 0.200 0.333 0.059

12Prudential Securities

Incorporated0.786 0.424 0.316 0.150 0.377 0.747 0.010

13 Allianz Dresdner Asset Mgmt 0.648 0.333 0.512 0.131 0.417 0.250 0.083

14Merrill Lynch Investment

Managers0.548 0.308 0.162 0.147 0.188 0.500 0.062

15 OppenheimerFunds 0.637 0.067 0.167 0.064 0.179 0.000 0.017

16MFS Investment

Management0.847 0.028 0.021 0.028 0.063 0.000 0.000

17Columbia Management

Group Inc.0.735 0.056 0.549 0.229 0.472 0.250 0.133

18Goldman Sachs Asset

Management0.800 0.000 0.357 0.283 0.500 0.135

19Morgan Stanley Investment

Advisors0.467 0.100 0.288 0.074 0.283 0.250 0.027

20American Express Financial

Advisors0.678 0.118 0.193 0.011 0.292 0.000 0.010

21 ING Investments LLC 0.708 0.227 0.049 0.006 0.105 0.000 0.024

22Banc One Investment

Advisors0.538 0.600 0.376 0.234 0.179 0.180

23JPMorgan Fleming Asset

Management0.833 0.571 0.400 0.158 0.300 1.000 0.200

24 T Rowe Price Associates Inc. 0.813 0.500 0.190 0.255 0.288 0.286 0.043

Mean Percentage Support 0.690 0.249 0.256 0.113 0.233 0.219 0.058

Figure 1A: Percentage Vote For Shareholder Proposals vs. Turnover Decile

0

0.05

0.1

0.15

0.2

0.25

0.3

1 2 3 4 5 6 7 8 9 10

Fund Turnover Decile

%V

ote

Fo

r P

rop

os

al

%for proposal

fitted line

Figure 1B: Percentage Vote Against Shareholder Proposals vs. Turnover Decile

0.7

0.72

0.74

0.76

0.78

0.8

0.82

0.84

0.86

1 2 3 4 5 6 7 8 9 10

Fund Turnover Decile

% V

ote

Ag

ain

st

Pro

po

sa

l

%against proposal

fitted line

Fund Voting Behavior with Respect to Investment Horizon

Table 4: Panel A

Fund Style Number of Funds

Number of Voting

Records

% Vote Cast “for”

% Vote Cast “against”

% Vote Cast “abstain”

% Vote Cast“unknown”

Value 39 6012 0.214 0.728 0.055 0.003

Growth 61 5641 0.173 0.760 0.066 0.000

Blend 41 8934 0.199 0.703 0.093 0.004

Balanced 16 2453 0.151 0.733 0.113 0.003

Others 71 5507 0.192 0.740 0.053 0.014

Table 4: Distribution of Shareholder Proposals Voting Records Based on Fund Style

Research Questions

Determinants of mutual funds’ voting policies across firms.

Examine the incentive structure of mutual funds to undertake activist role in voting behavior.

Investigate whether mutual funds engage in “Wall Street Walk” when dissatisfied with management.

Determinants of Voting Policies Across Firms

Mutual funds voting pattern varies across firms for a particular proposal type

Voting behavior is not influenced by the business ties (Davis and Kim (2005)

Gordon and Pound (1993) examine the determinants of voting outcome of shareholders’ proposals

We examine fund family voting behavior across firms and study whether voting is influenced by

Family Characteristics Firm Characteristics and Performance Governance Structure of Firm Types of Proposals Ownership Structure of the Firm

Dependent Variable: Percentage of votes cast in support for shareholder proposal p of firm i by all funds in family f.

Votes Cast as Support of

Proposals

Variable for Portfolio Construction

P1Mean

(Median)

P10Mean

(Median)

P-value for difference

(t-test for difference)

“ for”

FIRM SIZE0.393(0.125

0.154(0.019)

0.0003(0.18)

BOOK TO MKT0.451(0.50)

0.336(0.146)

0.14(0.42)

HISTORICAL LONG RUN EXCESS RETURN

0.423(0.382)

0.330(0.141)

0.25(0.50)

“ for” or “abstain”

FIRM SIZE0.480(0.50)

0.213(0.138)

<0.0001(0.38)

BOOK TO MKT0.521

(0.520)0.377

(0.268)0.05

(0.03)

HISTORICAL LONG RUN EXCESS RETURN

0.524(0.50)

0.359(0.20)

0.03(0.24)

Table 6: Mean (Median) Percentage Support on Shareholder Proposals in Extreme Portfolios Based on Size, Book-to-Market and Performance

“ for” as support of shareholder proposals

PROPOSAL TYPEGOVERNANCE

INDEX

High ATP Mean

(Median)[N]

Low ATPMean

(Median)[N]

P-value for difference(t-test for difference)

All

GIM0.345

(0.148)0.229

(0.019)0.0001(0.001)

BCF0.351

(0.143)0.224

(0.040)<0.0001(0.001)

ANTITAKEOVER

GIM0.819

(0.875)0.635

(0.694)0.007

(0.004)

BCF0.823

(0.875)0.620(0.6)

0.0002(0.002)

VOTING ISSUES

GIM0.304

(0.021)0.204

(0.154)0.31

(0.32)

BCF0.240

(0.021)0.238

(0.160)0.98

(0.47)

SHAREHOLDER WEALTH AND RIGHTS

GIM0.285

(0.176)0.235

(0.084)0.35

(0.22)

BCF0.252

(0.035)0.273

(0.198)0.69

(0.13)

EXECUTIVE COMPENSATION

GIM0.07(0.0)

0.103(0.0)

0.33(0.22)

BCF0.041(0.0)

0.110(0.0)

0.03(0.01)

DIRECTOR RELATED

GIM0.356

(0.333)0.117(0.0)

0.01(0.008)

BCF0.266

(0.026)0.179

(0.034)0.35

(0.33)

Table 7: Mean (Median) Percentage Support on Shareholder Proposals and Governance Indices

2R

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept 2.681 2.489 2.106 2.594 2.421 2.119

FAMILY SIZE -0.139 *** -0.139 *** -0.117 *** -0.133 *** -0.139 *** -0.117 ***

BUSINESS TIES FAMILIES -0.055 * -0.062 * -0.084 *** -0.062 ** -0.073 ** -0.088 ***

FIRM SIZE -0.089 *** -0.072 *** -0.055 *** -0.078 *** -0.057 *** -0.053 ***

BOOK TO MKT -0.148 *** -0.120 *** -0.129 *** -0.164 *** -0.134 *** -0.135 ***

HISTORICAL LONG RUN EXCESS RETURN

0.018 *** 0.003 0.012 ** 0.018 *** 0.005 0.013 **

MAJOR STOCK LISTING 0.205 *** 0.187 *** 0.128 ** 0.208 *** 0.199 *** 0.137 **

NUMBER OF PROPOSALS 0.005 *** 0.005 *** 0.006 *** 0.004 *** 0.005 *** 0.005 ***

GIM 0.019 *** 0.021 *** 0.008 ***

BCF 0.039 *** 0.047 *** 0.012 **

DUAL CLASS -0.114 *** -0.041 * -0.115 *** -0.041 *

PERCENT SHARE HOLD -0.446 -0.698 ** -0.393 -0.678 **

BLOCKHOLDER HOLD 0.002 *** 0.001 0.002 *** 0.001 *

INSIDER HOLD 0.003 *** 0.002 *** 0.002 *** 0.002 ***

ANTITAKEOVER 0.519 *** 0.526 ***

VOTING ISSUES 0.065 * 0.070 **

SHAREHOLDER WEALTH RIGHTS

0.049 0.057 *

EXECUTIVE COMPENSATION -0.071 ** -0.064 **

DIRECTOR RELATED 0.004 0.013

Family Fixed Effects YES YES YES YES YES YES

0.12 0.14 0.37 0.12 0.14 0.37

Number of Observations 5814 4395 4395 6133 4392 4392

Table 8: Determinants of Voting Policies across Firms : Vote cast “for” Considered as Support

Effect of Voting Records Release on Funds’ Reputation

Whether there exist any direct reputational effect for undertaking activist role in voting mechanism

Observe the next year funds’ asset flow after voting record release.

Dependent variable: Objective adjusted net asset flow of a fund over the next year of the mutual fund voting record release date.

Independent variable: Median percentage support by a fund over all shareholder proposals

2R

Model 1Support

Shareholder:“for”

Model 2Support

Shareholder:“for” or “abstain”

Model 3:Support

Shareholder: “for”

Model 4Support

Shareholder:“for” or “abstain”

Intercept -0.056 -0.051 -0.026 -0.018

MEDIAN PERCENT SUPPORT BY FUND

0.024 ** 0.011 * 0.024 ** 0.014 **

FUND SIZE 0.002 0.001 0.0008 -0.003

FAMILY SIZE 0.00001 0.00001 0.00001 0.00001

FUND AGE 0.003 0.003 0.004 0.004 *

FEE 0.020 0.022 0.006 0.006

S&P STAR 0.003 0.003 0.002 0.002

OAR 0.117 ** 0.113 *

4FACTOR ALPHA 0.196 ** 0.227 ***

PREV YEAR AVG NAF 0.285 *** 0.293 *** 0.294 *** 0.294 ***

Style Fixed Effects YES YES YES YES

0.47 0.46 0.47 0.47

Number of Observations 210 210 205 205

Table 9: Effect of Mutual Funds’ Support of Shareholder Proposals on Fund Flow

Mutual Funds’ Trading Behavior after Voting Records Release

Examine: Whether mutual funds engage in “Wall Street Walk” when dissatisfied with management.

Results: Mutual funds sell off their shares when they provide higher support in shareholders’ proposals.

Implications: Mutual funds who support shareholders’ proposals are not very

optimistic about the final outcome.

When they dislike managements’ policy they engage in “Wall Street Walk”

However, they undertake activist role before selling off their shares.

2R

Model 1: Vote Cast:“for”

Model 2: Vote Cast: “for” or “abstain”

Intercept 0.026 0.026

PERCENTGAE SUPPORT TO SHRHLD -0.016 *** -0.011 **

FIRM SIZE -0.004 ** -0.004 **

BOOK TO MKT -0.015 ** -0.015 **

EARNING-PRICE-RATIO 0.030 0.031

RETURN PAST 90 DAYS -0.036 *** -0.036 ***

MAJOR STOCK LISTING 0.078 *** 0.076 ***

ALL INST HOLD -0.002 -0.003

PREV QTR PERC HOLD BY FUND -4.36 *** -4.36 ***

BLOCKHOLDER HOLD 0.0001 0.0001

INSIDER HOLD -0.0003 -0.0003

GIM -0.0002 -0.0002

NUMBER OF PROPOSALS -0.0002 -0.0002

Family Fixed Effects YES YES

Fund Style Fixed Effects YES YES

0.07 0.07

Number of Observations 4873 4873

Table 10: Analysis of Mutual Fund Trading Behavior after Voting Records Release

Conclusions

Mutual funds undertake monitoring role

For proposals that are likely to increase shareholders’ wealth and rights.

In firms with weaker external monitoring mechanism In firms with entrenched management In firms where they are likely to have higher influence.

Mutual funds experience a positive reputational effect for undertaking an activist role in their voting behavior

If they disapprove managements’ policy they sell off their shares but before doing so they provide support to shareholders’ proposals.

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