Do fiduciary responsibilities have any effect on the behavior of firm insiders? In a series of studies, I find empirical evidence that stronger fiduciary duties reduce managerial risk taking. And that is not all. The evidence indicates that stronger fiduciary duties are effective in curtailing managerial compensation. However, heightened fiduciary duties lead to inferior returns for the firm’s investors, even after adjusting for the difference in risk taking. The results suggest that stronger fiduciary duties can mitigate agency conflict, but at the cost of lower risk-adjusted performance.
I analyze fiduciary duties in a unique setting – the British mutual fund industry – where trusts and corporations exist within the same industry. Prior to 1997, all British mutual funds had to be organized legally as trusts, and fund managers were subjected to a strict (trust) fiduciary standard. In 1997, this regulatory restriction was changed. Funds were permitted to organize as either trusts or corporations, and fund managers were subjected to the applicable fiduciary standard. (In contrast, the U.S. applies a uniform fiduciary standard under the Investment Company Act of 1940 regardless of the fund’s organizational form). Hence, the British fund industry offers a unique laboratory for empirical study of fiduciary standards.
Since there is no survivorship bias-free electronic database of British mutual funds that is publicly available, I created such a dataset by hand collecting fund-level data. I obtained the data from the Financial Times, which published an annual yearbook containing information on every mutual fund in the United Kingdom. I also obtained data on mutual fund returns electronically from Datastream.
Evidence indicates that trust law is more effective in curtailing opportunistic behavior. I find that mutual funds organized in trust form charge significantly lower fees than equivalent mutual funds organized in corporate form. The trusts also incur less risk than the corporations. However, after adjusting for the difference in risk taking, I find that the trusts underperform their corporate counterparts. These results indicate that the greater business flexibility of corporate law leads to greater agency conflict and risk taking, but also to potentially superior risk-adjusted performance. An investor who invests $100,000 in a trust, instead of an equivalent corporation, would save about $100 per year in agency costs, but would forgo about $1,300 per year in gross risk-adjusted performance. The findings are based on my papers, Do Fiduciary Duties Matter? (available here) and Trusts Versus Corporations: An Empirical Analysis of British Mutual Funds (available here).
A third paper, Competition in Financial Services: Evidence from British Mutual Funds (available here), uses the 1997 change in British regulations to examine the impact of organizational competition on the behavior of incumbent funds. The entry of the corporations was responsible for an increase in risk-taking by the incumbents (the trusts). In addition, entry of corporations led to greater efficiencies in the performance of the incumbent trusts. In short, trusts responded to competition from corporations by significantly altering their behavior in tangible ways that reflected their competitors.
These findings from the British mutual fund industry have implications for the current regulatory debate in the U.S. over whether to impose a uniform fiduciary standard on all investment professionals.
This post comes to us from Professor A. Joseph Warburton at Syracuse University.