Do Index Funds Monitor?

Passively managed index funds now hold over 30% of U.S. equity fund assets; this shift raises fundamental questions about monitoring and governance. We show that, relative to active funds, index funds are less effective monitors: (a) they are less likely to vote against firm management on contentious governance issues; (b) there is no evidence they engage effectively publicly or privately; and (c) they promote less board independence and worse pay-performance sensitivity at their portfolio companies. Overall, the rise of index funds decreases the alignment of incentives between beneficial owners and firm management and shifts control from investors to managers.

Keywords: Corporate Governance, Passive Investing, Index Investing, Exit, Monitoring, Voting

JEL Classification: G12, G14

Suggested Citation: Suggested Citation

Heath, Davidson and Macciocchi, Daniele and Michaely, Roni and Ringgenberg, Matthew C., Do Index Funds Monitor? (November 4, 2020). Swiss Finance Institute Research Paper No. 19-08, European Corporate Governance Institute – Finance Working Paper No. 638/2019, Accepted, Review of Financial Studies, Available at SSRN: https://ssrn.com/abstract=3259433 or http://dx.doi.org/10.2139/ssrn.3259433