Disengaged Owners and Financial Reporting: Evidence From Index Funds

Abstract

Index funds are an increasingly important part of the U.S. stock market with the average S&P 1500 firm having 22% of their equity held by index funds in 2018. Building on concurrent research finding that index fund managers engage less with portfolio firms than other investors, we expect firm-level index fund ownership to be associated with systematically different financial reporting decisions by firms. Using fund-level stock holdings, we find that greater index fund ownership is associated with less bias (greater frequency of missing earnings and fewer abnormal accruals) and less obfuscation (more readable, more negative, and more specific disclosures) in financial reporting. Additional analysis finds results consistent with this effect being due to lower engagement and not higher oversight. Further, we document that fund-level holdings are operationally different that institution-level holdings and that the use of institution-level classifications leads to different empirical implications.