Trusts versus Corporations: An Empirical Analysis of Competing Organizational Forms

I. Introduction II. The British Mutual Fund Industry III. RELATED LITERATURE IV. DATA V. Expenses VI. Performance VII. Endogeneity Concerns A. Matched Samples Approach B. Sample Selection Model Approach C. Fund Fixed Effects Approach D. Evaluation VIII. Conclusion I. INTRODUCTION We have witnessed the worst capital markets meltdown since the Great Depression. One cause of the financial crisis was a cavalier attitude toward risk and responsibility that led to firm managers making major mistakes in judgments and, in some cases, to outright expropriation of investors. The ensuing economic turmoil has led to a popular recommendation: expose firm insiders to greater fiduciary liability for their decisions. (1) This Article explores the ramifications of altering fiduciary standards by studying how two different business organizations, trusts and corporations, regulate their insiders. Trust law imposes stricter fiduciary obligations on insiders than corporate law does. Might insiders be less likely to misbehave in a trust as opposed to a corporation? Does the difference in organizational form influence management's performance or risk tolerance? By leaving less flexibility for management, strict fiduciary responsibilities can limit opportunistic behavior. But that strictness can also constrain business decision making. In other words, trusts and corporations strike different tradeoffs between agency conflict and flexibility in decision making. This Article quantifies the effects on managerial behavior and firm performance of the different standards of conduct required by these two organizational forms. This Article exploits a variation generated by a change in British regulations in the 1990s that allowed mutual funds to organize as either a trust or a corporation. The parallel existence of alternative types of organizational forms within one industry provides the key design feature of this study. The existence of the two types of funds offers a unique laboratory for the study of the effect of organizational form on agency conflict and firm performance. This Article is among the first to take an empirical approach to the subject and, hence, it fills a crucial gap in the literature. This Article examines governance at a more fundamental level than does the existing literature. A large amount of literature in corporate law and finance studies the effectiveness of governance mechanisms and investor protections on managerial behavior and firm performance. (2) While there is a large amount of empirical literature, most of that literature focuses on the corporation and, hence, takes organizational form as given. one strand of that literature examines the impact on firm performance and firm value of the many governance devices and concessions corporations can make to investors--such as covenants, control rights, voting rules, board composition, and takeover defenses--within the corporation. (3) However, these arrangements do not occur within an institutional vacuum; rather, they occur in an environment of laws and regulations. These laws and regulations may vary across organizational forms. For instance, the fiduciary responsibilities imposed upon decision makers in corporations are not the same as those imposed upon decision makers in trusts. (4) Yet the existing literature largely neglects study of non-corporate organizations. A second strand of literature examines differences in corporate governance structures across countries. (5) Such research focuses on exploiting variation in governance environments across countries, but within the corporate form. In contrast, this study exploits variation across organizational forms. This approach offers sharper variation at a fundamental level of governance and can help shed light on whether governance matters at all. The traditional (Miller-Modigliani) view of corporate finance assigns organizational form no role, since it is irrelevant in a frictionless environment. …