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Index funds own an increasingly large proportion of American public companies. The stewardship decisions of index fund managers—how they monitor, vote, and engage with their portfolio companies—can be expected to have a profound impact on the governance and performance of public companies and the economy. Understanding index fund stewardship, and how policymaking can improve it, is thus critical for corporate law scholarship. In this Article we contribute to such understanding by providing a comprehensive theoretical, empirical, and policy analysis of index fund stewardship. We begin by putting forward an agency-costs theory of index fund incentives. Stewardship decisions by index funds depend not just on the interests of index fund investors but also on the incentives of index fund managers. Our agency-costs analysis shows that index fund managers have strong incentives to (i) underinvest in stewardship and (ii) defer excessively to the preferences and positions of corporate managers. We then provide an empirical analysis of the full range of stewardship activities that index funds do and do not undertake, focusing on the three largest index fund managers, which we collectively refer to as the “Big Three.” We analyze four dimensions of the Big Three’s stewardship activities: the limited personnel time they devote to stewardship regarding most of their portfolio companies; the small minority of portfolio companies with which they have any private communications; their focus on divergences from governance principles and their limited attention to other issues that could be significant for their investors; and their pro-management voting patterns. We also empirically investigate five ways in which the Big Three could fail to undertake adequate stewardship: the limited attention they pay to financial underperformance; their lack of involvement in the selection of directors and lack of attention to important director characteristics; their failure to take actions that would bring about governance changes that are desirable according to their own governance principles; their decision to stay on the sidelines regarding corporate governance reforms; and their avoidance of involvement in consequential securities litigation. We show that this body of evidence is, on the whole, consistent with the incentive problems that our agency-costs framework identifies. Finally, we put forward a set of reforms that policymakers should consider in order to address the incentives of index fund managers to underinvest in stewardship, their incentives to be excessively deferential to corporate managers, and the continuing rise of index investing. We also discuss how our analysis should reorient important ongoing debates regarding common ownership and hedge fund activism. The policy measures we put forward, and the beneficial role of hedge fund activism, can partly but not fully address the incentive problems that we analyze and document. These problems are expected to remain a significant aspect of the corporate governance landscape and should be the subject of close attention by policymakers, market participants, and scholars.

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The active money management industry is characterized by both strong competitive pressure from passive investment vehicles and high fees. This paper investigates how the introduction of low-cost index funds affects fund company strategies. The retail mutual fund market is segmented, where unsophisticated investors rely on financial advisers and sophisticated ones invest directly. Exploiting the staggered entry of low-cost Vanguard index funds as competitive shocks, I show that, in response to competition, incumbents sold to self-directed investors reduce their fees by 5% of the mean; however, funds sold with broker recommendations increase their fees by 6% of the mean. Index fund entry also slows the growth of actively managed funds. The responsiveness of broker-sold fund flows to distribution fees increases, suggesting a shift in composition toward less elastic consumers. Further, incumbents increase the degree of active management. The results illustrate why mutual fund fees slowly decline in the aggregate despite competition from lower-cost alternatives. This paper was accepted by Gustavo Manso, finance .

Our experiments evaluate the role of information presentation in reducing violations of the Law of One Price in individual investor selection of index mutual funds. The results indicate that most individuals fail to minimize fees. However, individuals allocate nearly 27% (43%) more of their investment dollars to the lowest fee index mutual fund when receiving fee information in the form of a table compared to a graph presentation (in ten-year rather than one-year form). Overall, a simple change from table to graph fee presentation results in a statistically and economically significant reduction in the fees paid by investors.

This paper analyzes the relationship between GDP and the stock market over the long term, intending to understand the implications for Index Fund investments. A quantitative research method, using US (United States) GDP as an independent variable, and the S&P 500 index as a dependent variable, is employed. A population of 29 years, from 1990 to 2019, of data on US GDP and the S&P 500 from official US sources was used. Linear regression analysis with SPSS calculating techniques is performed to determine whether there is a relationship between GDP growth and the stock market (S&P 500). The results show a significant positive relationship between GDP growth and S&P 500 performance. β coefficient of the regression analysis of 0.911 shows a strong correlation between the GDP and the S&P 500. Our findings are also scientifically validated by the sig (P value) coefficient of 0.0000000000012. In addition, an R Square of 0.830 shows that our model explains all the variability of the response data around the mean at a level of 83%. The positive results of GDP and the stock market relationship, indicate considerable implications for Index Funds investments. Therefore, adding academic value to the practical financial implication aspects.

PurposeThis study aims to assess the relationship between cash management and fund performance in index fund portfolios.Design/methodology/approachUsing a sample of 104 index mutual funds that track the Standard and Poor 500 stock market index from January 1999 to December 2016, the authors employ quintile portfolios and different regression models to assess the differences in risk-adjusted monthly returns experienced by index funds managing different cash levels in their portfolios. To ensure the robustness of the results, different sub-periods and market states are considered in the analyses as well as other exogenous factors and fund characteristics affecting the level of portfolio cash holdings and index fund performance.FindingsResults show that index funds holding higher levels of cash and cash equivalents performed significantly worse than their low-cash counterparts. This evidence remains even after considering different sub-periods and bullish and bearish market conditions and controlling for fund expenses and other variables that could drive this cash-performance relationship.Originality/valueThis study expands the extant literature analyzing cash management in the mutual fund industry. More specifically, the analyses focus on index fund portfolios that replicate a specific benchmark, given that their performance differences should not be related to the market evolution but to the factors derived from the fund management and other exogenous issues. These findings are of interest to managers and investors willing to improve their risk-adjusted returns while investing as diversified as a stock market index.

Financial economics and corporate governance have long focused on the agency problems between corporate managers and shareholders that result from the dispersion of ownership in large publicly traded corporations. In this paper, we focus on how the rise of institutional investors over the past several decades has transformed the corporate landscape and, in turn, the governance problems of the modern corporation. The rise of institutional investors has led to increased concentration of equity ownership, with most public corporations now having a substantial proportion of their shares held by a small number of institutional investors. At the same time, these institutions are controlled by investment managers, which have their own agency problems vis-à-vis their own beneficial investors. We develop an analytical framework for understanding the agency problems of institutional investors, and apply it to examine the agency problems and behavior of several key types of investment managers, including those that manage mutual funds—both index funds and actively managed funds—and activist hedge funds. We show that index funds have especially poor incentives to engage in stewardship activities that could improve governance and increase value. Activist hedge funds have substantially better incentives than managers of index funds or active mutual funds. While their activities may partially compensate, we show that they do not provide a complete solution for the agency problems of other institutional investors.