Active vs. Passive: Information Acquisition in the Presence of Corporate Governance

Abstract

We provide a theoretical framework to understand the implications of corporate governance for the composition of the asset management industry. We allow investors to implement corporate governance in an otherwise standard information model. Our model generates new strategic complementarities in investors’ decisions to acquire information due to a conflict of interest when implementing corporate governance. Such strategic complementarities increase the proportion of passive investors in equilibrium, rationalizing the rising share of passive investment. Our results are robust to the various corporate governance approaches that passive investors take, and we provide a policy discussion on such approaches. Moreover, in our model, a rise in passive investment can increase both payoff volatility and price informativeness. We conclude with two relevant extensions to critical passive funds’ corporate governance issues: ESG policies and product market competition.

Keywords: mutual funds, passive investment, corporate governance, information acquisition, strate- gic complementarities, conflict of interests