Passive Debt Ownership and Corporate Financial Policy

Abstract

The rise in passively managed corporate debt funds has resulted in increasingly inelastic demand for corporate debt. In this study, we quantify how passive debt ownership affects firms’ financial policy. Using fund-specific flows to capture firm-level changes in passive debt ownership that are exogenous to firm fundamentals, we find that firms respond to higher levels of passive debt ownership by increasing leverage. The borrower-friendly terms provided by passive debtholders could theoretically lead to several potential changes in investment or payout policy. We show that passive debt holding does not affect investment policy. Instead, passive ownership predicts increased payouts — exacerbating shareholder-debtholder conflicts. Passive debtholders enable these effects by reducing aggregate ex-ante and ex-post monitoring. The presence of a bank monitor moderates the relationship between passive debt ownership and increased payout, reinforcing the importance of this monitoring channel.

Keywords: Passive Investing, Index Funds, Corporate Debt, Capital Structure, Real Investment, Payout Decisions, Monitoring

JEL Classification: G23, G32, G34, G35