Does Skin in the Game Matter? Director Incentives and Governance in the Mutual Fund Industry

Abstract

We use a unique database on ownership stakes of equity mutual fund directors to analyze whether the directors’ incentive structure is related to fund performance. Ownership of both independent and nonindependent directors plays an economically and statistically significant role. Funds in which directors have low ownership, or “skin in the game,” significantly underperform. We posit two economic mechanisms to explain this relation. First, lack of ownership could indicate a director’s lack of alignment with fund shareholder interests. Second, directors may have superior private information on future performance. We find evidence in support of the first and against the second mechanism.

Stewardship As A Factor In The Financial Performance Of Mutual Funds

“…Morningstar believes that fund managers who "eat their own cooking" will outperform abstemious counterparts (Spence, 2006). Recent studies lend support to Morningstar's conviction that "skin in the game" enhances fund performance (Cremers et al, 2005;Laise, 2006). For the next component of Fees, Morningstar assesses relative expense by referencing a compendium of comparison groups.…”

Differentiating control, monitoring and oversight

“…(Chen et al, 2008(Chen et al, , p. 2630(Chen et al, , 2675) ⑩ " […] one board overseeing all funds in the entire family […] the monitoring role of independent directors, who act as sole fiduciaries to the shareholders of the fund" (Kong and Tang, 2008, p. 193;197) ⑪ " […] directors have the important monitoring role of resolving a wide array of conflicts of interests between the advisory firm and the fund's shareholders." (Cremers et al, 2009(Cremers et al, , p. 1368) ⑫ "A second strand of the corporate governance literature focuses on the effectiveness of the board, as manager incentive alignment and effective board monitoring" (Chen and Huang, 2011, p. 313) ⑬ "However, fund directors monitor the investment performance of the funds that they oversee (often using consultants) as the primary indicator of output quality of the fund-which is then used as the main determinant of retaining or firing the management company, as well as (jointly) negotiating the fee upward or downward" (Ding and Wermers, 2012, p. 6) Control, monitoring and oversight keywords underlined…”

Director Connections in the Mutual Fund Industry

“…Ferris and Yan (2007) attribute this lack of an effect to the fact that tenure may also proxy for director experience which would have a positive effect on the fund. Cremers, Driessen, Maenhout and Weinbaum (2009) study the impact of director ownership of the fund on the performance of the fund. They find evidence that director ownership is positively related to fund performance, and funds with high levels of director ownership outperform those with low levels director ownership.…”

“…This literature has focused on how various incentives impact a director's ability to carry out his fiduciary responsibilities to the fund, finding that factors which align director incentives with the shareholders (and away from the fund managers) allow the director to better execute his fiduciary responsibility (Tufano and Sevick (1997), Del Guercio, Dann and Partch (2003), Ferris and Yan (2007), Khorana, Tufano and Wedge (2007), Cremers, Driessen, Maenhout and Weinbaum (2009)). My paper adds to the fund governance literature by explicitly studying a non-fiduciary mechanism through which the directors influence fund performance.…”