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Directors’ Ownership and Closed-End Fund Discounts

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Abstract

This paper investigates whether ownership by independent directors could provide them with effective monitoring incentives and thus help reduce discounts in the closed-end fund industry. We find that after controlling for fund observed and unobserved characteristics with the latter proxied by fund fixed effects, independent directors’ ownership is negatively related to fund discounts. We further find that funds whose independent directors have larger ownership are more likely to employ appropriate measures to reduce fund discounts, such as buying back outstanding shares, adopting managed distribution plans (MDPs) if they do not have such plans in place, or increasing the minimum payout targets under their existing MDPs. These findings may imply that independent directors become better monitors when they have larger ownership in the funds they oversee and are thus more diligent in taking actions to diminish discounts.

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Notes

  1. For example, Mock et al. (1988), McConnell and Servaes (1990, 1995), Hermalin and Weisbach (1991), Holdeness et al. (1999), and McConnell et al. (2008) document a significant relation between insider ownership and corporate performance. However, Demsetz and Lehn (1985), Agrawal and Knoeber (1996), Loderer and Martin (1997), Cho (1998), Himmelberg et al. (1999), and Demsetz and Villalonga (2001) do not find such a significant relation after taking into account the potential endogeneity problem.

  2. Several papers shed some light on the relation between insider and/or block ownership and closed-end fund discounts. For example, Barclay et al. (1993) report that closed-end funds with larger block ownership also have larger discounts. Del Guercio et al. (2003) examine the portion of common shares held by insiders and outside block holders and do not find any significant relation between the combined ownership and discounts.

  3. In this paper, among the 1,246 fund-year observations from 2002 to 2004 that we have directors’ ownership information on, only 25 or 2 % of the fund-year parings have independent directors’ ownership that is more than 1 % of funds’ outstanding common shares. But none of them has independent directors’ ownership above 5 %.

  4. For example, Nuveen Investments manages more than 100 closed-end funds. Nuveen California Dividend Advantage Municipal Fund or Nuveen Municipal Value Fund is each a fund under its management. Nuveen Investments is their common advisor and their fund complex/family’s name. Note that funds’ boards of directors are different from the board of directors of their investment advisor.

  5. For example, the 1940 Act requires that at least 40 % of a fund’s board be independent. The amendments to the 1940 Act in 2001 and 2004 increase the required percentage of independent directors to 50 % and 75 %, respectively.

  6. Before January 31, 2002, however, closed-end funds disclosed directors’ percentage share ownership in the funds they oversee complying with the disclosure requirements applicable to publicly traded companies.

  7. One reason for this is that it is common in the fund industry for directors to sit on multiple boards in a fund family. Thus, they have to allocate their limited financial resources among all the funds they oversee.

  8. www.etfconnect.com.

  9. According to the closed-end fund statistics reported by the ICI, the total assets managed by U.S. closed-end funds by the year end of 2004 are $254 billion. The document is available at www.ici.org.

  10. The following description of data, unless otherwise indicated, refers to 2004.

  11. They are Convertible, Corporate General, Corporate High Yield, Domestic Equity, Europe Stock, Government Bond, Income, International Bond, Latin America, Loan Participation, Mortgage, Multisector Bond, Muni California, Muni National, Muni New York, Muni Single State, Pacific/Asia, and World Stock.

  12. A discussion of the consistency of this method can be found in Chen et al. (2008) and Chapter 15 of Wooldridge (2002).

  13. Independent directors’ ownership in the family they oversee (FamOwn_Indep) is an in-sample measure in this paper. That is, it is calculated as the sum of independent directors’ fund-level ownership (FundOwn_Indep) of each sample fund within the family.

  14. Closed-end funds do not disclose interested directors’ compensation. Typically, interested directors do not receive compensation from a fund for serving as directors.

  15. This is motivated by the observation that around 15 % of the sample funds primarily invest in foreign securities.

  16. For example, among the 352 funds that have data for 2002 and 2003, 80 or 22.7 % report total independent directors’ ownership in 2003 that is different from that reported in 2002. For the 366 funds that have data for 2003 and 2004, 147 or 40.2 % report total independent directors’ ownership in 2004 that is different from that reported in 2003.

  17. We also tried an alternative indicator variable for larger ownership by independent directors, which is defined to be one if the fund’s FundOwn_Indep in one year is larger than the 75th percentile of FundOwn_Indep in that year, and got very similar results as in Column (3) of Table 1.

  18. For example, if FundOwn_Indep is originally below the mean, a one standard deviation increase will make it rise above the mean. Then such an increase in FundOwn_Indep is associated with a reduction of 1.71 percentage points in discounts.

  19. Independent directors’ compensation from a fund family is comparable to that received by corporate directors (e.g., Cremers et al. 2009). It is arguably a better measure of independent directors’ friendliness to the management than the compensation they receive from an individual fund they oversee (e.g., Tufano and Sevick 1997; Del Guercio et al. 2003). As a sensitivity check, we also used independent directors’ compensation from the fund (FundComp_Indep) and did not find that it had any significant effect on discounts.

  20. A staggered board structure means only a part of the directors are elected each year. A unitary board structure means a fund family employs the same board of directors for all funds within the family. Unitary is an in-sample variable in this paper. That is, we assign Unitary to be 1 for a fund if all the funds in my sample within its family have the same board of directors.

  21. Cf. “Report of the Advisory Group on Best Practices for Fund Directors”, June 24, 1999, by the ICI. The complete document is available at www.ici.org.

  22. Closed-end funds rarely discontinue their existing MDPs for reasons other than merger, open-ending, or liquidation. In my sample, only two equity funds dropped MDPs in July 2003 but reinstated them in April 2004.

  23. We use the approval from boards of directors of a liquidation, open-ending or merger as indicating the event of a termination because it better reflects directors’ attitude and action regarding a major restructuring than the actual execution of a restructuring. The reason is that terminating a closed-end fund requires shareholders’ vote. Although in most cases shareholders’ vote is consistent with the board’s vote, it is possible that their votes are opposite to each other. In the latter case, the actual execution or non-execution of a termination does not stand for the board’s decision.

  24. The statistics are based on 37 share repurchases that are publicly announced and thus whose announcement dates can be identified from Factiva or Lexis Nexis. Other repurchases are retrieved from funds’ annual reports whose exact announcement or execution dates are unavailable.

  25. Indeed, 21.3 % or 20 out of the equity funds in my sample instated MDPs before 2003. Among them, three equity funds have MDPs since fund inception.

  26. These three variables are possibly related to the probability of fund activities. For example, FundComp_Indep is what independent directors would lose if they approve a fund termination. Share repurchases, MDPs, or fund terminations are typically the response to and/or consequence of prolonged deep discounts. Therefore, including Discount is necessary. Finally, if a fund in the family is attacked by dissidents, the management may be alerted and respond by trying to reduce discounts of all funds in the family. And such effect could be proxied by AttackFamily.

  27. Let y be the dependent variable and x the explanatory variable. Then the semi-elasticity of y with respect to x is defined as d(lny)/dx, where dx means a change from 0 to 1 if x is a dummy. Such a definition is a bit different from that of marginal elasticity that measures the percentage change in the probability in response to a unit percentage change in the explanatory variable. The reason for using the semi-elasticity as defined in this paper is for the ease of interpreting the coefficients in the logit regressions because many explanatory variables are already measured in percentage points.

  28. The correlations between the three variables vary from 0.68 to 0.99 and all are significant at less than 1 %.

  29. We also tried an alternative indicator variable for large ownership by independent directors, which is defined to be one if the fund’s FundOwn_Indep in one year is larger than the 75th percentile of FundOwn_Indep in that year, and got very similar results.

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Acknowledgments

Zhao acknowledges the financial support from the Shanghai Pujiang Program and the National Natural Science Foundation of China (under the grant number 71102135).

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Authors and Affiliations

  1. State Information Center of China, Beijing, China

    Yongchun Ju

  2. School of Finance, Shanghai University of Finance and Economics, Shanghai, China

    Linying Zhao

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Appendix

Appendix

Table 1 Variable Definitions and Summary Statistics. Panel A defines main variables. Panel B reports the summary statistics of main variables at the fund level over the period 2002–2004. For each variable, the three-row block provides its sample mean, standard deviation, and median, respectively. Panel C reports the summary statistics of dummy variables. Panel D reports the number of fund activities in each year over the period 2003–2005. Note that MDP_Activity is measured only for equity funds
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Ju, Y., Zhao, L. Directors’ Ownership and Closed-End Fund Discounts. J Financ Serv Res 45, 241–269 (2014). https://doi.org/10.1007/s10693-012-0156-9

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