The Effect of Passive Investment on a Firm’s Information Environment

Abstract

Passive investment strategies (i.e., indexing) have grown substantially over the past twenty years to over $3 trillion in assets, but there is little empirical evidence on the effect of indexers on a firm’s information environment. Owing to the passivity of their investment strategy, indexers likely differ from active institutional investors in their demand for financial information, which could have implications for the supply of financial information in the market. I find that increases in indexed ownership are associated with a reduction in the quantity and quality of financial information provided by two key suppliers of financial information – analysts and managers. Specifically, I find that increases in indexed ownership are associated with increases in analyst following, but analysts are less accurate in their forecasts. In addition, I find that increases in indexed ownership are associated with management issuing fewer forecasts. These findings stand in contrast to the documented positive association between institutional ownership and the information environment. Overall, my results indicate that, all else equal, increases in indexed ownership are associated with deteriorations in a firm’s information environment, which is a particularly relevant finding given the significant growth in indexing in recent years.