The Product Market Effects of Index Inclusion

86 Pages Posted: 1 Sep 2021 Last revised: 9 Mar 2022

See all articles by Varun Sharma

Varun Sharma

Kelley School of Business, Indiana University; Nanyang Business School; London Business School

Date Written: August 1, 2021

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

Suggested Citation

Sharma, Varun, The Product Market Effects of Index Inclusion (August 1, 2021). Available at SSRN: https://ssrn.com/abstract=3897160 or http://dx.doi.org/10.2139/ssrn.3897160

Varun Sharma (Contact Author)

Kelley School of Business, Indiana University ( email )

1275 E 10th St
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United States
8128377912 (Phone)
47405 (Fax)

HOME PAGE: http://www.sharmav.com

Nanyang Business School ( email )

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Singapore, Singapore 639818
Singapore

HOME PAGE: http://dr.ntu.edu.sg/cris/rp/rp02032

London Business School ( email )

Sussex Place
Regent's Park
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United Kingdom

HOME PAGE: http://www.sharmav.com

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