Ajay Khorana, associate professor of finance
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After the discovery of massive mutual-fund scandals a few years ago, the U.S. Securities and Exchange Commission (SEC) proposed a controversial rule requiring that 75 percent of mutual-fund board directors (including the chairman) be independent of the company. But that percentage might not be high enough to best serve shareholders, according to a new study.
When it comes to fund mergers, shareholders might benefit most from boards that are 100 percent independent, found Ajay Khorana, associate professor of finance at Georgia Tech College of Management; Peter Tufano, professor of financial management at Harvard Business School; and Lei Wedge, assistant professor of finance at the University of South Florida. Their study, titled "Board Structure, Mergers, and Shareholder Wealth: A Study of the Mutual Fund Industry," will be published soon in the Journal of Financial Economics.
In the study, the researchers examined whether greater independence increased the likelihood that boards would approve fund mergers - especially of poorly performing funds. "We look at fund mergers because they are important board decisions, not taken lightly, that affect the very existence of a fund," Khorana says. "Since the early 1990s, the number of fund mergers in the U.S. has increased substantially."
While fund mergers usually benefit investors by reversing the problem of poor returns, the unions sometimes cost board members their seats and compensation. "Boards that are most closely aligned with shareholder interests might be the most vigilant in merging a poorly performing fund out of existence, even when this results in the loss of their compensation," Khorana says. "More independent boards seem less willing to tolerate poor performance before initiating a merger. They are more likely to act quickly to stem shareholder losses."
The researchers, who examined mergers from 1999 to 2001, found that boards whose memberships were only 75-percent independent didn't behave that differently than those with fewer independent members. Boards had to be totally independent for the research team to see a significant difference. Having an independent chairman didn't make a difference unless the whole board was independent, too.
The purpose of the study was to inform the heated debate on the proposed SEC regulations. "We're careful not to over-interpret the results," Khorana says. "This is only one piece of evidence, but it does indicate that independent boards seem to take actions that are in investors' best interests. However, we acknowledge that boards do more than approve mergers, and that changing board structure is not without costs."
After the SEC approved the 75-percent/independent chair regulation in 2004, the proposal met with strong opposition from the mutual fund industry, and the U.S. Chamber of Commerce filed a federal suit challenging it. Last year, the U.S. Court of Appeals for the D.C. Circuit ruled that the SEC had violated the Administrative Procedure Act by failing to consider the costs of the requirement and sent it back to the SEC. When the Chamber challenged the rule again this year, the court ruled that the SEC had not given the public opportunity to comment. Now taking comments on the proposal (see this SEC Website), the SEC has not given a timetable for reconsidering the proposed rule.
For more information, contact Khorana at 404-894-5110 or
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