Trusts Versus Corporations: An Empirical Analysis of Competing Organizational Forms

A. Joseph Warburton, Syracuse University

Abstract

This paper studies the effects of organizational form on managerial behavior and firm performance, from an empirical perspective. Managers of trusts are subject to stricter fiduciary responsibilities than managers of corporations. This paper examines the ramifications empirically, by exploiting data generated by a change in British regulations in the 1990s that allowed mutual funds to organize as either a trust or a corporation. I find evidence that trust law is effective in curtailing opportunistic behavior, as trust managers charge significantly lower fees than their observationally equivalent corporate counterparts. Trust managers also incur lower risk. However, evidence suggests that trust managers tend to underperform their corporate counterparts, even after adjusting for the differences in risk. These results show that the business flexibility granted by corporations leads to greater agency conflict and risk taking, but also to potentially superior risk-adjusted performance. An investor who invests $100,000 in a trust, instead of an equivalent corporation, would save about $100 per year in agency costs, but would forgo about $1,300 per year in gross risk-adjusted performance. The results have implications for corporate governance design, suggesting that heightened fiduciary duties can enhance investor protection by mitigating agency conflict and lessening managerial risk taking, but at the possible cost of inferior risk-adjusted performance.