Passive investors and loan spreads
Summary
Focus
Since the mid-2000s, the popularity of index funds as an investment vehicle has surged among institutional and retail investors. The growing ownership share of index funds raises questions about their influence on the governance and monitoring of the firms in which they invest. If passive funds affect monitoring and corporate governance, their proliferation will affect firms' creditors. Banks are an important type of creditor. As major suppliers of credit, they have a vested interest in monitoring the financial health and performance of their borrowing firms to mitigate credit risk.
Contribution
We examine how banks adjust their loan pricing when firms have a higher share of passive index fund investors as shareholders. To do so, we measure US public firms' passive ownership and match these holdings data with granular syndicated loan data. Our findings highlight the intricate and often indirect link between non-bank financial institutions, in our case index funds, and banks.
Findings
We find that loan spreads increase with passive ownership by index funds. Our analysis shows that higher loan spreads reflect increased firm risk due to reduced shareholder oversight. Supporting this interpretation, we find a stronger increase in loan spreads among firms for which shareholder oversight is generally more important in mitigating risk. Further evidence suggests that banks increase their monitoring efforts in response to changes in shareholder composition, which is costly and reflected in loan spreads.
Abstract
Over the past decades, index funds have amassed substantial ownership stakes in publicly traded firms. Index funds' rapid growth raises questions about their influence on governance and monitoring, as well as the consequences for other stakeholders. This paper examines how banks adjust their loan pricing when firms have a higher share of passive index fund investors as shareholders. Using syndicated loan data, we find that loan spreads increase with passive ownership and provide evidence consistent with higher loan spreads reflecting increased risk due to reduced shareholder oversight. Supporting this interpretation, we find stronger effects among firms in which shareholder oversight has more impact. However, the increase in loan spreads is not fully accounted for by changes in firm risk. Suggestive evidence points towards banks increasing their monitoring efforts in response to changes in shareholder composition, which is costly and reflected in loan spreads.
JEL Classification: G21, G23, G32
Keywords: passive ownership, institutional investors, bank monitoring, syndicated loans
