Sunday, February 7, 2010
Exit, Voice and Fee Liability in Mutual Funds, by John Morley, Yale Law School Center for the Study of Corporate Law, and Quinn Curtis, Yale School of Management; Yale University - Law School, was recently posted on SSRN. Here is the abstract:
Unlike shareholders of ordinary companies, mutual fund shareholders do not sell their shares - they redeem them from the issuing funds for cash. We argue that this uniquely effective form of exit almost completely eliminates mutual fund investors’ incentives to use voting, boards and fee liability. Investors will never become active in their funds regardless of the investors’ sophistication or the size of their stakes and regardless of whether the mutual fund market is competitive. We also catalogue a number of unintended and harmful ways in which exit distorts voting, boards and fee liability. Exit interacts with voting, for example, to make firing managers impossible and to prevent investors from receiving notice of fee increases. Exit also interacts with fee liability to cause recoveries to go to the wrong investors and to discourage investors from moving to lower-fee funds. Though exit gives investors a powerful tool to protect their interests, the net effect of exit on many investors is ambiguous, because investors who do not use their rights to leave underperforming funds cannot expect activism by other investors to improve the funds. Ultimately, exit causes mutual funds to look more like products than ordinary companies. Voting, boards and fee liability should therefore be eliminated. Whatever benefits they now achieve could be achieved more effectively and at lower cost by product-style regulation that applies automatically without investor action or that prompts investors to use exit rights effectively.