The authors find that the quality of governance of a mutual fund tends to mirror the governance behavior of the firms at which the directors were previously employed. This “contagion” effect is evident with directors from firms or mutual funds known to be unfriendly to shareholders and with directors from other financial firms. The contagion effect does have a positive aspect; boards composed of directors with a strong governance background tend to have a positive effect on governance.

The authors show that the employment history of directors is an important determinant of a fund’s corporate governance. In particular, previous employment at firms with a poor governance record or at firms in the financial industry tends to lead to poor governance outcomes for the mutual fund. There is insufficient evidence to suggest that subsequent outside employment of a current director leads to degeneration in the quality of governance.

The findings in this article are particularly relevant to advisers and potential investors in mutual funds. Given the increased availability of personal information, it is relatively easy to investigate the employment history of board members to confirm that they have not been connected with any corporate wrongdoing.

Fund director names are gathered from the S&P Capital IQ database and matched against SEC filings (Form N-CSR) to create a table containing year, director, and firm data. Information provided by publicly listed firms on Form 10-K is used to establish connections between outside employment and fund directorships. The nature of the connection (i.e., independent, affiliated, or other) is also noted. The authors measure the connectivity of the board by the proportion of board members who are connected. The governance quality of a firm is measured across two characteristics: its G-index, which is a measure of overall governance, and its litigation record. They use the fund’s expense ratio as a proxy for the governance of the mutual fund and cross-check it with the fund’s management fees.

The authors then apply pooled regressions to test their different hypotheses. Control variables are included to account for such variables as fund returns, fund age/size, board size, type of fund (index versus active), and fund objective. The expense ratio is the dependent variable in the regressions.

Although it is difficult to objectively assess governance quality, there may be other non-governance-based explanations for fluctuating expense levels, which may have affected some of the results.

The authors’ findings confirm that a detailed study of the composition of a mutual fund board and directors’ employment history is a necessary prerequisite before investing in the fund. Although it is intuitive that the contributions of a director to the board of a mutual fund will be somewhat shaped by his or her previous experience, the authors’ findings appear to discount the individualistic nature of human beings. Not all employees of poorly governed firms (including senior executives) necessarily exhibit poor governance behaviors nor do they carry these behaviors into future roles. Likewise, not all employees from firms with a strong culture necessarily act accordingly. That said, corporate culture will tend to be dictated by the behavior of the top-ranked employees, and it is these employees who most likely receive the majority of directorship offers.