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Having Skin in the Game Helps Fund Managers
19 May 2005
Mutual funds perform better when their directors have significant ownership in the funds they oversee according to a new study, “Does Skin in the Game Matter? Director Incentives and Governance in the Mutual Fund Industry,” conducted by Martijn Cremers of the Yale School of Management, Joost Driessen of the University of Amsterdam, Pascal Maenhout of INSEAD, and David Weinbaum of Cornell. The paper uses recently available data to study the link between mutual fund performance and the ownership stakes of their directors. “While we can’t say that ownership by directors directly causes funds to perform well, our results suggest that funds with the right incentive structure in place, one that aligns the interests of the directors with those of shareholders, have better performance,” said Cremers. The researchers assembled a database of the 2001 fund holdings and cash compensation of directors at the largest US stock mutual fund families. In the sample, independent directors held an average of $8,058 in each fund overseen and $67,170 in total, with average total cash compensation of $137,517. Non-independent directors held, on average, $23,027 in each fund and $88,075 in total. Among the study’s findings was that the ownership stakes of independent directors matter for fund performance, especially when their cash compensation is relatively low. For example, funds with independent directors with large investments in the fund, known as having “skin in the game,” and relatively low pay, outperformed other funds on average by 3.18 per cent per year between January 2002 and June of 2004, on a risk-adjusted basis. However, ownership by independent directors matters only if non-independent directors also have large investments. “Contrary to recent moves to expel non-independent directors from the boardroom, it is exactly those funds in which the non-independent directors’ incentives are aligned with those of the shareholders that we find the strongest fund performance,” said Cremers. The results show that the percentage of independent directors on the board had no effect on performance. Mutual fund fees did factor into the results as previous studies have also shown, but not significantly so. Cremers and his co-authors argue that the link between fund performance and ownership could be explained by good directors signaling their quality by accepting shares in the funds they oversee, while high ownership stakes may also make them better monitors. Similarly, better funds may offer ownership as compensation to signal their quality.