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The financial sector is unique in being largely self-governed: the majority of financial firms’ shares are held by other financial institutions. This raises the possibility that the monitoring of financial firms is especially undermined by conflicts of interest as a result of personal and professional links between these firms and their shareholders. To investigate this possibility, we scrutinize the aspect of the financial sector’s self-governance that is directly observable: mutual fund companies’ voting on their peers’ stocks. We find that considerations specific to investee firms’ membership in the same industry as their investors do indeed impact voting. This impact is in the direction of supporting the investee’s management. We show that the own-industry effect reduces director efficacy and lowers firm value as a result. We extend our analysis to other financial companies and show that they also tend to vote more favorably when it comes to their peers. Our results suggest that peer support is a corrupting factor in the financial sector’s governance.

This paper was accepted by Wei Jiang, finance.

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