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Exposing the dual role of mutual funds in connection with investment banks

A new study from the University of Florida highlights the complex relationship between mutual funds and broker banks, and why it’s one for concern.

GAINESVILLE, Fla. – Institutional investors and investment banks are two key players in today’s financial system. The relationship between these two is complex, and according to new research is one that deserves more public scrutiny due to conflicts of interest.

In a new study, University of Florida finance professors Nitish Kumar and Yuehua Tang examine the dual role of mutual funds as both clients and shareholders of broker banks.

“On one hand, institutional investors (like mutual funds) are prized clients of investment banks because they often pay billions of dollars in commissions per year for brokerage and research services,” explained Kumar. “On the other hand, these institutions manage trillions of dollars of assets and often hold a significant amount of stocks of investment banks with which they have brokerage business ties. Institutional investors essentially play the dual role of brokerage clients and large shareholders of investment banks.”

Nitish Kumar and Yuehua Tang

Assistant Professor of Finance Nitish Kumar and Emerson-Merrill Lynch Associate Professor Yuehua Tang.

Among their findings, Kumar, Tang and co-author Kelsey Wei of the University of Texas at Dallas, show that mutual funds are almost twice as likely to hold and overweight by 12.3% stocks of their broker banks. As the researchers explain, mutual funds then provide valuable voting support to brokers’ management in contentious proposals at shareholder meetings.

“What we’re seeing in this relationship is a conflict of interest,” Tang said. “Asset managers, as large shareholders of investment banks, are expected to contribute to shareholder governance of banks. However, potential private benefits due to brokerage business relationships could weaken their incentives to exert shareholder monitoring. These conflicts of interest could adversely affect both market integrity and the governance of investment banks.”

Based on their first findings, the researchers then investigated whether mutual fund portfolio overweighting and pro-management voting support are economically important enough that mutual funds gain preferential treatment from broker banks. To do this, the researchers used IPO allocation to illustrate such benefits since broker banks often serve as IPO underwriters. Using a comprehensive IPO dataset from UF’s IPO expert Jay Ritter, the researchers found a strong connection between a fund family’s allocations of underpriced IPOs and the voting support that the family displays for investment banks.

Specifically, among fund families with brokerage ties, those that provided greater voting support to the lead underwriters’ management received more than 10 times as many shares of severely underpriced IPOs as otherwise similar fund families.

The researchers note that fund families’ reputational concerns appear to be a disciplinary force against the documented quid pro quo behavior.

With these findings in mind, Kumar and Tang advise mutual fund investors to be vigilant. Given that relationships between banks and funds are established at the fund-family level, individual funds bearing the costs of suboptimal portfolio and voting decisions are often not the ones that receive hot IPO allocations by their families.

The full paper,Customers as Friendly Shareholders: Uncovering the Complex Mutual Fund-Broker Relationship,” is forthcoming in Management Science.


Nitish Kumar – University of Florida Warrington College of Business – Assistant Professor

Yuehua Tang – University of Florida Warrington College of Business – Emerson-Merrill Lynch Associate Professor

Kelsey D. Wei – University of Texas at Dallas Jindal School of Management – Associate Professor