Strong Managers, Weak Owners: The Political Roots of American Corporate Finance

By Mark J. Roe | Go to book overview

CHAPTER 8
Mutual Funds

MUTUAL FUNDS, despite huge financial resources of $1.2 trillion—half in stock—rarely participate in corporate governance. They channel funds from distant individuals to industry, gather information about industrial investments that their owners cannot easily get and evaluate, and do the paperwork that individuals begrudge. They are not intermediaries that get funds from disparate investors, combine them into concentrated holdings, and then enter the corporate boardroom to represent their shareholder beneficiaries and, if need be, check management.

In the 1930s some funds began to act as monitoring intermediaries. They underwrote securities, were active in bankruptcy reorganizations, and participated in management.1 The 1936 tax act, followed by the 1940 Investment Company Act, helped induce them to stop.

The cutoff's timing is ironic, because Berle and Means had just published their finding that the atomization of shareholdings had shifted power from shareholders to managers. Key political players then wanted to ban mutual fund (and other banker) control of industrial firms. Explanations for their preference for passivity include popular mistrust of large financial institutions, public-spirited rules to foster stable, honest mutual funds for the average investor, the accidents of tax doctrine, and a faint interest group story as some political actors favored local managers over Wall Street.


THE INVESTMENT COMPANY ACT OF 1940

Mutual funds pool investments from many investors, who get diversification and buy expert management from the fund's managers. Even when the Investment Company Act of 1940 was passed, cognoscenti recognized that mutual funds offered a third function: “[The investor] may be able to join in

____________________
1
See SEC, Report on the Study of Investment Trusts and Investment Companies 370–71 (1939–1942) [SEC Investment Company Study]; SEC, Abuses and Deficiencies in the Organization and Operation of Investment Trusts and Investment Companies, pt. III, H.R. Doc. No. 270, 76th Cong., 1st Sess. 2501 (1939); Investment Dilemma—Trusts Forced to Choose between Drastic Reorganization and High Tax, under New Law, Business Week, July 11, 1936, at 45, 46.

-102-

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