Disengaged Owners and Financial Reporting: Evidence from Index Funds
47 Pages Posted: 3 Oct 2019
Date Written: August 28, 2019
The amount of equity held by index funds is an increasingly important share of the U.S. stock market. This rise in ownership by passive investors that are, by construction, restricted from making trading decisions has the potential to dramatically impact firm decisions. We expect that compared to other owners, index funds have lower levels of engagement with portfolio firms, leading firm managers to make systematically different decisions as the percent of firm owners who are “disengaged” increases. Using fund-level stock holdings, we directly measure index fund ownership for each firm and examine its association with financial reporting. Consistent with lower engagement with financial reporting, we find that greater ownership by index funds is associated with fewer accruals, greater frequency of missing earnings expectations, and a greater likelihood of misstatements. Our findings are consistent with index funds engaging with firms less, leading to decreased managerial incentives to both bias earnings information and invest in financial reporting quality.
Keywords: Financial Reporting, Passive Investing, Index Funds, Misstatements
JEL Classification: G10, M10, M41
Suggested Citation: Suggested Citation