Why Governance Might Work in Mutual Funds

Abstract

The Supreme Court’s recent decision in Jones v. Harris Associates L.P. has highlighted the potential for agency conflicts in mutual funds, whose advisors have the de facto power to award themselves high fees. While the surrounding debate has focused on the extent to which market competition replaces the need for fee litigation, there appears to be a growing consensus that fund governance, through the use of voice, is unlikely to be effective. The use of voice is commonly said to be hampered by collective action problems; more recently, scholars have argued that it is further weakened by the easy availability of exit. Yet while the easy availability of exit may discourage the use of voice, the easy availability of exit may also encourage voice. This paper explains how the easy availability of exit from mutual funds encourages shareholder voice, at least in theory. By analyzing the responsibility of 401(k) plan fiduciaries to prudently select investment options that plan participants can choose from, the paper also explains why mutual fund governance might work in practice.

Keywords: mutual funds, corporate governance, fee litigation, shareholder voting, exit, voice

JEL Classification: D72, G23, G34, K20, K22