The Effect of Organisational Form on Investment Products: an empirical analysis of the UK unit trust industry

• DOI: http://doi.org/10.1111/j.1467-8683.2007.00644.x
• Published date: 01 November 2007
• Author: Yoshikatsu Shinozawa
• Date: 01 November 2007

The Effect of Organisational Form on

Investment Products: an empirical

analysis of the UK unit trust industry

Yoshikatsu Shinozawa*

The mutual versus plc debate has now branched out to include discussion of the potential

benef‌its to consumers from alternative organisational forms. This paper investigates whether

performance, risk and fee levels differ across mutual and plc ownership groups in the UK unit

trust industry. To this end, this paper uses monthly time-series data for UK unit trusts industry

for the years 2000 to 2005 and compares recorded performance from a consumer perspective by

organisational form. The paper f‌inds some difference between the two organisational groups

with respect to the annual management fee charged and risk-exposures, which seem to affect

returns of their unit trusts. Consistent with recent studies, such results suggest that diversity

of organisational form fosters product variations across UK investment products.

Keywords: Governance, demutualisation, unit trust, performance

Introduction

Recent years have seen major corporate

failures in the UK f‌inancial sector.

Examples include the collapse of Equitable

Life, the large life assurance mutual, and a

takeover of Abbey National, the UK’s f‌irst

demutualised mortgage bank, by BSCH, a

Spanish bank. Theseevents have reinvigorated

debate concerning the corporate governance

of f‌inancial institutions and its impact upon

organisational form (see, for example, the HM

Treasury’s Myners Review, 20041; the All-Party

Parliamentary Group for Building Societies &

Financial Mutuals, 2006). This article contrib-

utes to this debate from a consumer’s perspec-

tive by considering whether or not the chosen

organisational form impacts on the quality of

f‌inancial products offered. To this purpose,

this paper tests for differences between

mutuals and public limited companies in

terms of performance of unit trusts they

market to clients.

Unit trusts are investment schemes which

combine investors’ money and invest in bulk

in a selection of shares, bonds, and cash. Unit

holders hope to benef‌it from professional

management companies’ investment of their

wealth. In return, all the unit trusts pay for the

investment service. Most unit trusts charge an

initial fee of 5 per cent and an annual manage-

ment fee of 1.5 per cent on the market value of

the unit trust’s underlying assets2.

Most academic literature on the UK unit

trusts and the US mutual funds has examined

whether fund performance is consistently

superior to market benchmarks so as to test

the eff‌icient market hypothesis. The majority

of evidence has provided little support for

the fund managers’ superior investment skills

(Malkiel, 1995 and Carhart, 1997, for the US

mutual funds; Otten and Bams, 2002, for the

European mutual funds; Byrne et al., 2006, for

the UK unit trusts). Expanding from the tradi-

tional fund management literature, this paper

contributes to understanding the demutuali-

sation effect on f‌inancial products by testing

whether unit trusts managed by the mutuals

perform differently from those managed by

the proprietary counterparts.

For the following reasons, the UK unit trust

industry provides a laboratory for a natural

experiment regarding which organisational

form best supports successful providers of

*Address for correspondence:

The Business School, Lough-

borough University, Ashby

Road, Loughborough, Leices-

tershire LE11 3TU. E-mail:

y.shinozawa@lboro.ac.uk

1244 CORPORATE GOVERNANCE

Volume 15 Number 6 November 2007

© 2007 TheAuthor

Journal compilation © 2007 BlackwellPublishing Ltd, 9600 Garsington Road,

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retail f‌inancial products from a client/

customers’ perspective. First, the UK unit trust

industry is highly competitive, playing an

important role in the UK f‌inancial service

sector. The industry offered more than 1,600

unit trusts with total assets under manage-

ment of £347 billion by the end of 2005.

Through the tax-saving schemes, 13.5 million

individuals invest in unit trusts,accounting for

more than 75 per cent of the total unit holders

(Investment Management Association, 2005).

Secondly, most UK unit trust management

companies are fully owned by large f‌inancial

groups whose organisational form is ether

mutual or proprietary. Besides their traditional

products such as mortgages or insurance poli-

cies, these f‌inancial groups attempt to retain

their customers by offering a range of other

f‌inancial products. These offer their clients

economies of scope in their investment prac-

tice. A unit trust is just one investment vehicle

both organisational groups manage and dis-

tribute through their subsidiaries.

Last but not least, by focusing on the trade-

off of fees and risk of a unit trust it is hoped to

broaden discussion of the relative eff‌icacy of

competing organisational forms. The levels of

fees and risk of a unit trust should be consid-

ered as complementary metrics of unit trust

performance (James, 2000; Golec and Starks,

2004; the US Securities and Exchange Com-

mission, 2007). Fee and risk features can

induce differing agency problems with alter-

native forms of organisation or ref‌lect the

objectives held by each form of organisation.

Alternatively,it may simply be product market

competition that jointly sets the fee levels and

risk taking levels of unit trusts in an intensely

competitive segment of the market for f‌inan-

cial products. Therefore the analysis of the unit

trust performance below provides an attrac-

tive testbed of alternative and possibly con-

f‌licting views.

Previous literature

Prior literature has provided three theoretical

motivations for the choice of a particular

organisational form: agency theory, stake-

holder theory and market competition. Most

of the literature revolves around agency

theory, which addresses the separation of

ownership and control, and ensuing problems

(Jensen and Meckling, 1976). The expense pref-

erence hypothesis, advocated by early schol-

ars, highlights sources of relativelyweak mana-

gement control in mutual organisations (for

example O’Hara, 1981). The disadvantages of

the mutual form can arise from (i) lack of an

effective market for corporate control, (ii) the

dispersed ownership and lack of large block

shareholdings, which can induce a free-rider

problem, and (iii) the absence of share option

incentives designed to align interests between

managers and owners.

Consequently, some consider the mutual

structure as a less eff‌icient form of organisa-

tion in mitigating opportunistic or expense

preference behaviour of managers (Masulis,

1987). In contrast, the seminal papers by Fama

and Jensen (1983a and 1983b) have advanced

the comparative advantage hypothesis, sug-

gesting that the differing organisational forms

f‌lourish where they have comparative advan-

tages over other forms in their specif‌ic indus-

try (Fama and Jensen, 1983a and 1983b.)

According to Fama and Jensen, each organisa-

tional form is characterised by distinctive gov-

ernance arrangements. These attributes con-

stitute one part of their opportunistic adapta-

tion to competitive pressures. These disparate

contractual structures amongst owners, man-

agers and customers, the organisation-specif‌ic

governance systems, are effective in bringing

success in particular markets. In a similar vein,

Mayers and Smith (1986) develop the mana-

gerial discretion hypothesis, interpreting the

advantages of different organisational forms as

being contingent upon the degree of manage-

rial autonomy needed for a specif‌ic business

activity. According to their hypothesis, the

proprietary form has advantages over its

mutual counterpart in lines of business that

require greater management autonomy

because the proprietary form can benef‌it from

more cost-effective monitoring and incentive

mechanisms than the mutual from. On the

other hand, because of the dual function of

owner and customer, the mutual form is more

eff‌icient in those businesses where segments’

conf‌lict of interest between owners and cus-

tomers induce severe agency problems.

Another extension of the aforementioned

hypotheses is the substitution hypothesis

(Williamson, 1983; Rediker and Seth, 1995;

Chen and Steiner, 1999), which predicts that

substitution effects prevailamong various con-

trolling devices to deal with managerial

opportunism. In the case of the mutual form,

the internal controls can compensate for the

lack of the market-based disciplines by greater

use of a supervisory board (O’Sullivan and

Diacon, 2003).

In the corporate governance literature, a

challenge to the agency framework arises from

the stakeholder perspective. Despite the fact

that some variants exist in stakeholder theory

(Freeman, 1984; Donaldson and Preston, 1995),

a common claim associated with stakeholder

theorists is that f‌irms should consider the

wider interests of stakeholders, while agency

THE EFFECT OF ORGANISATIONAL FORM ON INVESTMENT PRODUCTS 1245

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Journal compilation © BlackwellPublishing Ltd. 2007