6.1 Introduction

Nearly half a century ago, U.S. Congress adopted the Investment Company Act because of its concern with the potential for agency conflicts in investment funds, including mutual funds. The Act gave shareholders the right to vote on adviser fees and directors, thereby opening the door to governance through the use of voice. Shareholder activism in mutual funds nevertheless remains uncommon, which is widely attributed to collective action problems. Because shareholders in mutual funds are typically household investors, their stakes are said to be too small to make activism worthwhile. In a recent article, John Morley and Quinn Curtis offer a further explanation for fund shareholders' passivity, arguing that the use of voice is discouraged by the easy availability of exit — the ability to redeem one's shares in the fund.1 This argument is based on Albert Hirschman's influential book, Exit, Voice and Loyalty,2 yet it fails to fully capture the subtle implications of Hirschman's work. After all, the easy availability of exit may also encourage voice. This Chapter explains how the easy availability of exit from mutual funds encourages shareholder voice, at least in theory. By analyzing the responsibility of 401(k) plan fiduciaries to prudently select investment options that plan participants can choose from, this Chapter also explains why mutual fund governance might work in practice.

Before getting to the heart of the matter, it is useful to clarify the meaning of "voice" in the context of fund governance. Hirschman defined voice as any attempt "to change, rather than to escape from, an objectionable state of affairs, whether through individual or collective petition to the management directly in charge, through appeal to a higher authority with the intention of forcing a change in management, or through various types of actions and protests."3 Morley and Curtis apply a similarly broad definition that encompasses both voting to lower fees or change managers, as well as putting pressure on the fund's directors ("lobbying"). Their analysis focuses on voting, and shows that mutual fund shareholders can be expected to consistently prefer exit to voting. By contrast, the act of putting pressure on the fund's directors — or directly on the fund adviser — features less prominently in the analysis. As we will see, it is this informal use of voice that holds promise as a tool of fund governance.