The Agency Problems of Institutional Investors

Question 1

How does a shift from “closet indexing” to a more concentrated ownership encourage active funds to engage in stewardship activities in their portfolio companies?
A) Concentrated ownership increases potential benefits from stewardship, making engagement more worthwhile.
B) Concentrated ownership reduces the ability to engage with firms.
C) Active funds avoid stewardship due to free-rider problems.
D) Index funds engage in more stewardship than concentrated active funds.

Answer 1

A

Question 2

Are active funds becoming more or less risky due to the transition from closet indexing to more concentrated portfolios by active funds
A) Less risky, because concentrated portfolios diversify better.
B) More risky, because larger bets on fewer stocks increase exposure to firm-specific risks.
C) Neither more nor less risky, as active funds remain diversified.
D) Less risky, as concentrated ownership ensures more predictable returns.

Answer 2

B

Question 3

What are some potential sources of agency problems in index funds?

Answer 3

Free-rider problem, cost of stewardship, and conflicts of interest.

Question 4

What problem do index fund managers face that prevents them from engaging more in portfolio company governance?

Answer 4

They bear the full cost of engagement but share the benefits with all investors.

Question 5

What is a primary reason investment managers may not act in the best interest of beneficial investors regarding stewardship?
A) They bear the full cost of stewardship activities but capture only a small fraction of the benefits.
B) Investment managers have full alignment with beneficial investors’ interests.
C) Fees charged by investment managers ensure strong incentives for stewardship.
D) Investment managers are legally barred from engaging in stewardship.

Answer 5

A

Question 6

Why are activist hedge funds less afflicted by the agency problems that impact other investment managers?
A) They have high-powered incentives and often take concentrated positions, increasing their incentive to enhance value.
B) They focus on short-term stock movements, not governance.
C) They are smaller and less influential.
D) They cannot invest in equity securities, avoiding conflicts of interest.

Answer 6

A

Question 7

What is the primary focus of the paper regarding agency problems of institutional investors?
A) The stewardship roles of investment managers in corporate governance.
B) The regulatory frameworks governing mutual funds.
C) The relationship between mutual fund managers and specific stocks.
D) The techniques used by hedge funds to increase portfolio value.

Answer 7

A

Question 8

What is one systemic cost of the rise of index funds in corporate governance?
A) Index funds have poor incentives to engage in stewardship, potentially affecting governance adversely.
B) Index funds have drastically increased the costs of financial intermediation.
C) Index funds reduce market diversification.
D) Index funds excessively interfere in corporate governance.

Answer 8

A

Question 9

How does the compensation structure of hedge funds differ from index funds regarding stewardship incentives?
A) Hedge funds use performance-based fees, encouraging active engagement.
B) Hedge funds avoid engagement, similar to index funds.
C) Index funds have stronger incentives to engage in governance.
D) Hedge funds rely on fixed management fees like index funds.

Answer 9

A

Question 10

Why do mutual funds often avoid direct shareholder activism?

Answer 10

To maintain business ties with corporations

Question 11

What role does the free-rider problem play in discouraging index funds from stewardship?

Answer 11

Any improvements benefit all funds tracking the same index, not just the one making the effort.

Question 12

Why do some policymakers advocate for increased regulation of mutual fund fees?

Answer 12

To incentivize greater investment in stewardship activities.

Question 13

Why do institutional investors often underinvest in stewardship activities?

Answer 13

Stewardship costs are borne entirely by investment managers, while benefits are shared among all shareholders.

Question 14

How does the “free-rider problem” affect index fund managers’ willingness to engage in stewardship?

Answer 14

Index fund managers avoid costly stewardship as the benefits are distributed to all funds tracking the same index.

Question 15

What is a primary reason hedge funds are more effective at governance engagement than mutual funds?

Answer 15

Hedge funds have concentrated portfolios and incentive structures that reward value increases.

Question 16

How do “closet indexers” undermine active mutual fund governance?
a) By closely mirroring index weightings, they avoid meaningful governance improvements.
b) By prioritizing shareholder activism, they alienate corporate executives.
c) By overweighing underperforming firms, they increase risks to their portfolios.
d) By charging high fees, they divert resources from stewardship efforts.

Answer 16

A

Question 17

5. Which of the following challenges does the “collective action problem” present in corporate governance?
   a) It prevents institutional investors from aligning their investment objectives with beneficial owners.
   b) It leads to fragmented voting practices during shareholder meetings.
   c) It reduces the incentive for individual funds to invest in governance, as benefits are shared collectively.
   d) It allows hedge funds to dominate corporate governance discussions at the expense of mutual funds.

Answer 17

C

Question 18

Why do index funds allocate minimal resources to stewardship activities?

Answer 18

The fee structures of index funds are too small to justify significant spending on governance.

Question 19

How does “overweighting” stocks in a portfolio influence stewardship decisions?
a) Overweighting reduces a fund’s incentive to engage in stewardship since returns are already optimized.
b) Overweighting increases stewardship benefits for the fund, as the stock has a larger impact on its performance.
c) Overweighting prevents funds from divesting from poorly governed companies.
d) Overweighting forces funds to prioritize pro-management stances in governance.

Answer 19

B

Question 20

What is the primary focus of activist hedge funds in governance engagement?

Answer 20

What is the primary focus of activist hedge funds in governance engagement?
a) Broadly improving governance across industries.
b) Targeting specific firms where governance improvements can yield significant value increases.
c) Reducing management compensation across portfolio companies.
d) Promoting systemic regulatory changes to enhance shareholder protections.

Question 21

How do “structural limitations” impact index funds’ governance capabilities?

Answer 21

They limit index funds’ resources for stewardship due to their low-cost business model.

Question 22

What is a suggested policy solution to address agency problems in institutional investors?

Answer 22

Require more disclosure and transparency from investment managers about stewardship practices.

Question 23

What are the types of II?

Answer 23

Index funds (passive)
Active funds (as closet indexers)
Henge funds (very active)

Question 24

Popularity of index funds is driven by

Answer 24

Low costs, tax advantages, evidence of them outperforming actively managed funds

Question 25

Index fund agency problems

Answer 25

Their compensation is based on fixed % of assets under management. No incentive fees on the change of portfolio value

Question 26

Active funds agency problems

Answer 26

Small monetary benefit from stewardship, investing in stewardship activities can reduce relative performance of the fund, II want to keep good relationships with the managers because managers can in return provide more business - private costs.

Question 27

Hedge funds

Answer 27

Offer services to more sophisticated investors -> their regulations are more lenient -> more risky positions, more leverage, more activism.
Without mutual fund support, hedge funds are hardly a threat to the corp mgm.

Question 28

Why are hedge funds compared to index funds incentivised to have relatively larger number of staff for stewardship activities relative to the number of their portfolio companies?

Answer 28

Hedge funds’ concentrated portfolios, performance-driven compensation structures, and active governance strategies necessitate relatively larger stewardship teams to maximize their influence and returns. In contrast, index funds’ broad portfolios and passive strategies limit their incentives to allocate significant resources to stewardship activities.