The Role of Index Fund Ownership in the Era of Say-on-Pay *

Abstract

This paper studies the effects of index fund ownership on CEO compensation by exploiting recurring Russell index assignments during the Say-on-Pay era. This setup allows us to draw a causal relationship between passive ownership by index funds and parts of CEO compensation that better align incentives during a period when it is easier for shareholders to voice their opinion on executive compensation. We find that an increase in index fund ownership leads to greater use of performance-vesting provisions and relative performance evaluation, higher delta, and a shift from cash toward equity awards but does not impact compensation complexity or hidden compensation. We also identify proxy voting and large ownership stakes as potential mechanisms. Overall, our analysis suggests that index funds play pivotal roles in nudging CEO compensation towards reducing agency conflict, facilitated by the Say-on-Pay rule.

Keywords: JEL category: G23, G28, G32, J33, M52, M55 Index Fund ownership, executive compensation, performance-vesting awards, corporate governance, Say-on-Pay

JEL Classification: G23, G28, G32, J33, M52, M55