The Effect of Organizational Form on Firm Performance.

Abstract

While much empirical literature studies agency conflict and firm performance within the corporate form of legal organization, this dissertation studies agency conflict and firm performance across two organizational forms, corporations and trusts. Trust law imposes higher fiduciary responsibilities on managers than corporate law, which is likely to limit opportunistic behavior by trust managers. At the same time, they can also constrain managerial flexibility in decision making. To analyze the effect of this trade-off, this dissertation exploits variation generated by a change in British regulations in 1997 that removed a requirement that mutual funds organize as trusts, allowing them to organize as either trusts or corporations. This regulatory shock offers a natural laboratory to study of the effect of organizational form on firms’ performance. Three chapters explore different aspects of this issue. Chapter II examines whether funds behave differently when organized as trusts versus corporations. The results demonstrate that trust law is more effective than corporate law in curtailing opportunistic behavior, as trust managers charge significantly lower fees than their observationally equivalent corporate counterparts. Trusts also incur lower risk than corporations. While the business flexibility of corporate funds leads to greater agency costs and risk taking, it also leads to greater risk-adjusted performance. Given these results, a natural question is whether organizational competition can impact the performance of the financial services industry as a whole. Chapter III analyzes this issue for the British fund industry. Increased competition led to an increase in risk taking and risk-adjusted performance within the industry, though it also resulted in higher direct costs for consumers. Chapter IV critiques efforts by U.S. lawmakers to mitigate agency conflict inherent in mutual fund operations. The U.S. follows a corporate model, requiring that all funds have boards of directors and grant voting rights to investors. Chapter IV outlines shortcomings of the corporate model and contrasts the alternative trust model pursued by other countries, notably the U.K. This dissertation shows that agency costs, risk taking behavior, and managerial performance are impacted by the different fiduciary duties inherent in trusts and corporations, making different organizational forms appealing to different investor clienteles.