Quasi-Indexers' Ownership and Capital Budgeting Efficiency of Firms

Abstract

Quasi-indexing institutional investors, who either explicitly replicate targeted indexes or actively manage highly diversified portfolios that are implicitly benchmarked to indexes, increasingly dominate institutional investing. Their passive strategies and diversified portfolios may reduce their incentives to monitor holding firms and acquire firm-specific information, thereby harming the holding firms' capital allocation efficiency. Alternatively, their long holding periods and low turnover might pressure them to voice their concerns about holding firms and reduce their informational asymmetry, thus pushing firms to allocate their capital to its best use. This study demonstrates that greater quasi-indexer ownership is associated with less deviation of firms' estimated marginal q from the optimal benchmark, indicating greater capital budgeting efficiency. In the full sample, this primarily reflects alleviation of underinvestment. Moreover, the positive relationship between quasi-indexer ownership and capital budgeting efficiency is more prominent for firms with a higher intangible to total assets ratio, regardless of underinvestment or overinvestment.

Keywords: apital budgeting efficiency, Marginal q, Quasi-indexers