Does skin in the game matter? Director incentives and governance in the mutual fund industry

We use a unique database on the ownership stakes of equity mutual fund directors to analyze whether the directors’ incentive structure is related to fund performance. We find that the ownership stakes of both independent and non-independent directors play an economicallysubstantial and statistically significant role. Specifically, funds in which directors have low ownership stakes, or “skin in the game”, significantly underperform. We posit two economic mechanisms to explain this relation. First, a lack of ownership could lead directors to be less active monitors, increasing agency costs between fund shareholders and fund managers. Second, directors may have superior private information on future mutual fund performance, choosing not to invest in those funds that they expect to underperform. We find evidence in support of the monitoring mechanism and against the private information mechanism. In particular, we find no evidence that directors are able to avoid funds that underperform. Finally, our results cannot be explained by the previously documented relation between fund governance and mutual fund fees.