The Product Market Effects of Index Inclusion

Abstract

I investigate how a firm's inclusion in an index affects its product market outcomes. I compile a micro-level dataset that matches firms' investors with firms' products and customers. Using a plausibly exogenous change in firms index membership, which increases the proportion of firms' equity held by benchmark-constrained funds that track the index, I show that firms (i) reduce product prices, especially for products with lower market share, (ii) generate higher sales, but at the cost of lower profitability, and (iii) introduce new products and diversify. Furthermore, with a higher proportion of such investors, large firms get a competitive advantage and sell similar products 7% cheaper, resulting in a 30% gain in market share. To shed light on the mechanism, I provide evidence that inelastic demand from benchmark-constrained investors allows firms to raise more equity and invest in expanding their customer base and product portfolio. A general equilibrium model with product-level habits and heterogeneous firms further corroborates these findings. These results show that benchmarking can increase product affordability but potentially at the cost of higher market concentration.

Keywords: Investor Heterogeneity, Benchmarking, Index Inclusion, Product Prices, Product Market, Customer Compositions, Industry Competition

JEL Classification: G23, G11, G12, D4, D12