Passive Ownership Research Articles

Foreign Direct Investment and Its Impact on India's Economic Growth

One of the most important ways for nations to integrate into the global economy and promote economic growth and development is through foreign direct investment, or FDI. It means that an organization or individual from one nation invests resources into the assets or commercial ventures of another nation. Foreign direct investment (FDI) denotes a long-term stake and a substantial amount of control or influence over the management of the foreign firm, in contrast to foreign portfolio investments, which consist of passive ownership of securities. Intra-company loans, reinvestment of earnings, and ownership of equity are ways to attain this control. FDI is so more than just a cash investment; it's a calculated action that has the power to influence the host nation's economic environment. Three main components make up foreign direct investment (FDI) according to the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD): equity capital, reinvested earnings, and intra-company loans. Acquiring shares in a foreign company signifies ownership and control through equity capital. The investor's portion of profits that are reinvested in the overseas business to support development and expansion, as opposed to being sent home as dividends, is known as reinvested earnings. Funds borrowed or lent between the parent business and its overseas affiliates are referred to as intra-company loans, and they reflect continuing financial exchanges inside the corporate network. FDI may be divided into two primary categories: vertical FDI, which involves a company investing in a host nation to move upstream or downstream in different stages of production, and horizontal FDI, which involves a company replicating its home country-based activities at the same point of the value chain in a host country.

Passive Investment and Share Repurchases

SYNOPSIS We investigate the association between passive investment and share repurchases, both of which are at historically high levels and the subject of increased scrutiny. We first document that firms with more passive ownership exhibit higher levels of repurchase activity. Next, and more importantly, we find that firms with passive ownership conduct more “suspect” repurchases that result in reported earnings that meet or beat analysts’ earnings forecasts, and this effect is more pronounced for firms with performance-based equity compensation incentive plans. We also find that repurchase activity more negatively affects firms’ future employment, capital expenditures, and performance when the firm has more passive owners. We conclude that passive investment is associated with an increase in the quantity and a reduction in the quality of firms’ repurchase activities. Our study provides evidence that passive institutional investment may allow opportunistic management behavior rather than serving the monitoring role traditionally associated with institutional ownership. Data availability: Data are available from the public sources cited in the text. JEL Classifications: M41; G32; G35.

Passive Institutions and Long-Run CEO Compensation: Evidence from Proxy Voting

A one-standard-deviation increase in passive ownership leads to a 25% increase in the compensation duration. I find proxy voting is the channel through which passive investors affect incentive horizons. Since the passage of the Dodd-Frank Act, passive funds tend to vote more against Say-on-Pay (SOP) proposals, and SOP proposals are less likely to pass with higher passive ownership. Moreover, passive ownership is associated with a greater number of shareholder-sponsored compensation proposals and an increased likelihood of these proposals passing. The overall findings indicate that passive institutions work to lengthen CEO compensation to align incentive horizons, and proxy voting is the mechanism through which they exert influence.

Strategic borrowing from passive investors

Abstract We find that short sellers manage risks by strategically borrowing shares in stocks with significant ownership by passive investors. This practice increases securities lending demand for stocks with substantial passive ownership, resulting in improved price efficiency, higher lending fees, and increased short interest in these stocks. Consistent with the risk mitigation motive, these stocks show reduced risks of unexpected fee hikes and loan recall, longer loan durations, and attract more informed short sellers. These effects are particularly pronounced in hard-to-borrow stocks where short-sale constraints are binding. Our study suggests that passive investing helps alleviate short-sale constraints by reducing the risks associated with stock borrowing.

Effects of partial passive ownership on the desirable production timing of the public utility in a mixed upstream market

AbstractWe consider partial passive ownership (PPO) between upstream and downstream private firms and examine an endogenous production timing of a public utility in a mixed upstream market. We show that the production timing will shift from simultaneous to sequential as the PPO level decreases when the private share of the public utility ownership is low, which is mostly socially desirable. We also show that a higher private share does not yield socially desirable production timing irrespective of the PPO level, while a lower private share under the public utility's followership (Cournot competition) is optimal and time‐consistent when the PPO level is low (high). Our findings suggest that public utility ownership can be used as an industrial policy tool to coordinate desirable production timing.

Passive cross‐holdings, horizontal differentiation, and welfare

AbstractWe study how passive cross‐holdings affect product differentiation and welfare in a Cournot duopoly. We show that increasing unilateral ownership stimulates total investments, and therefore improves social welfare. Such cross‐holdings should not be controlled in view of social welfare. However, we identify an inverted‐U (a negative) relationship between consumer surplus and ownership when the demand is small (large). Then a government might apply intervention thresholds for passive ownership if it uses consumer surplus as the appropriate standard for antitrust enforcement. We further consider symmetric bilateral cross‐holdings and show that our results are in general robust, but increasing ownership will generate more serious competition harms than unilateral cross‐holdings. Thus, special concerns need to be given to bilateral cross‐holdings.

The Role of Passive Investors in Corporate Governance and Socially Responsible Investing: Evidence from Shareholder Proposals

We study whether the substantial rise in passive ownership reshapes activist shareholders’ behavior in sponsoring shareholder proposals, which shareholders use to address issues they believe are crucial for the sustainable growth of a company. Our findings reveal a positive impact of passive investors on the initiation of governance, socially responsible investing (SRI), and an aggregate of both proposals. Interestingly, we show that managerial ability and board co-option potentially moderate their link. In the subsequent analysis, we note a constructive influence of passive investors on post-initiation outcomes, evidenced by an increase in withdrawal and voting percentage of proposals corresponding to heightened levels of passive ownership. These findings suggest that passive investors foster communication between activists and management and endorse the case even when it progresses to the voting stage. More importantly, the market values these proposals positively as reflected in higher observed buy-and-hold returns. Finally, our results are robust to instrumental variable analysis using Russell reconstitution as an exogenous shock. Taken together, our study offers broad implications that passive investors can indirectly engage in promoting sustainable practices by encouraging activist investors to sponsor governance and socially responsible proposals, a collaborative approach where shareholders contribute to sustainability efforts.

Time Variation in the News–Returns Relationship

Abstract The speed of stock price reaction to news exhibits substantial time variation. Higher risk-bearing capacity of financial intermediaries, lower passive ownership of stocks, and more informative news increase price responses to contemporaneous news; surprisingly, these interaction variables also increase price responses to lagged news (underreaction). A simple model with limited attention and three investor types (institutional, noninstitutional, and passive) predicts the observed variation in news responses. A long–short trading strategy based on news sentiment earns high returns, which increase when conditioning on the interaction variables. The interactions we document are robust to the choice of news source.

Research spillovers and partial passive ownership by a public enterprise

ABSTRACT This study examines the impacts of partial passive ownership (PPO) by a public enterprise on firm’s research and development (R&D) decisions in the presence of research spillovers. We find that PPO always increases welfare in a mixed duopoly, while it only increases (decreases) welfare in a private duopoly when the spillover rate is high (low). We also show that privatisation policy can increase (decrease) welfare when both PPO and spillover rates are high (low) under R&D competition. In addition, we examine research joint ventures (RJVs) and find that welfares in both mixed and private duopolies under RJVs are always higher than those under R&D competition, while privatisation policy always increases welfare regardless of PPO and the organisational form of RJVs. Therefore, the effects of PPO by a public enterprise crucially depend not only on spillovers rate, but on the type of RJVs formation and the implementation of privatisation policy.

Effects of partial passive ownership in a successive endogenous timing game with R&D spillovers

AbstractThis study explores the effect of partial passive ownership (PPO) in a successive two‐round endogenous timing game wherein firms choose research and development (R&D) investments in the first round and then subsequently choose quantities in the second round. We show that each firm prefers to be a quantity leader independent of the timing of R&D decisions, but the welfare‐inferior Cournot competition is an equilibrium of an endogenous production timing game. Moreover, we discover that the equilibrium of an endogenous R&D timing game crucially depends on the PPO level and R&D spillovers rate, while the R&D timing coordination may not be socially desirable unless both are low or high. Our findings suggest that the R&D leadership position of a PPO holder can play an anticompetitive role in the coordination of R&D competition with higher R&D spillovers rates and PPO levels.

More Risk, More Information: How Passive Ownership Can Improve Informational Efficiency

Abstract We identify a novel economic mechanism through which passive ownership positively affects informational efficiency in the cross-section of firms. Passive investors’ inelastic demand lowers a firm’s cost-of-capital, inducing it to take more risk. The higher cash flow variance, in turn, incentivizes active investors to acquire more precise private information, pushing up price informativeness for firms with high passive ownership. High passive ownership also implies higher stock prices and higher stock-return variances. An increase in the aggregate size of passive investors amplifies these cross-sectional differences. We also document complementarities in firms’ real investment and investors’ information choices that can cause information crashes. Received May 31, 2020; editorial decision January 4, 2023 by Editor Holger Mueller. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online

Foreign passive ownership and tariff‐induced free technology transfer under vertical integration

AbstractThis study constructs a vertical structure model in which a foreign firm holds upstream partial passive ownership and examines tariff‐induced free technology transfer from the firm to its downstream rival. We show that a strategic tariff can induce technology transfer when the share of foreign ownership is large, which always yields higher welfare under both vertical separation and integration, while vertical integration can better induce technology transfer. We also consider an extensive analysis with some variations, such as upstream or downstream competition, downstream passive ownership, government commitments to no‐tariff policies, and foreign firm commitments to no‐licensing strategies, and discuss policy implications regarding the pro‐competitive effect of foreign passive ownership when free technology transfer is involved.

Passive Ownership and Aggressive Non-GAAP Reporting

Passive Ownership and Aggressive Non-GAAP Reporting

Passive Ownership and the Environment

Passive Ownership and the Environment

The Role of Passive Ownership in the Era of Say-on-Pay

The Role of Passive Ownership in the Era of Say-on-Pay

Passive Ownership and Short Selling

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Passive Investors and Audit Quality: Evidence from the U.S.

The rise of index funds, or passive investing, in recent decades has caused heated debates over the efficacy of passive investors' stewardship role in corporate governance. Our study adds to this emerging line of literature by examining whether passive investors enhance the quality of financial statement audits, a key aspect of corporate governance mechanisms. We exploit the yearly Russell index reassignment, which provides us with an ideal setting to study the causal relation between passive institutional investors (i.e., index trackers) and firms' audit quality. Examining firms closely surrounding the Russell 1000/2000 cutoff line, we find that higher passive ownership leads to higher audit quality proxied by audit fees. To investigate the channel through which passive investors influence audit-related governance issues, our evidence from auditor ratification voting records suggests that passive investors do ‘voice’ their opinion on low-quality audits. Such effort also leads to a higher likelihood of auditor turnover in the following year. In the cross-sectional analysis, we also find that the positive effect of passive investors on audit quality is more pronounced in firms with higher agency costs. Thus, our study supports the view that passive investors play an active role in improving corporate governance.

Partial passive ownership holdings and R&D risk choices in a differentiated duopoly

This study investigates the R&D risk choices in a differentiated duopoly, in which a firm has partial passive ownership holdings (P.P.O.s) in its rival. Firms perform R&D projects with identical expected outcomes but different risk degrees. It mainly finds that: (1) the P.P.O.s make both firms more willing to take R&D risks; (2) compared with the firm which owns a share of its rival, its partially owned rival is more willing to take R&D risks; (3) for both firms, their private incentive for R&D risk is lower than the social incentive. However, the P.P.O.s may make the private optimum closer to the social optimum.

The Shift from Active to Passive and its Effect on Intraday Stock Dynamics

Recent empirical studies argue that passive funds tend to propagate liquidity shocks to the underlying securities, thus increasing stock volatility. We document that the growing importance of the closing auction has caused trading in ETFs, much like trading in the underlying stocks, to shift significantly towards the Close. Motivated by this result, we use intraday data to analyse the relation between passive ownership and stock price dynamics. The main conclusion is that the effect is concentrated at the end of the continuous trading session and at the Close. This is arguably due to the concentration of portfolio trades in the order flow during that phase. We find that among US stocks, a two standard deviation increase in ETF ownership would generate a 2.99% relative increase in volatility for the median stock near the Close. In contrast, we find little evidence that prices of passively held securities are more volatile at the beginning of the trading session.

Passive forward ownership and upstream collusion

We investigate the effects of passive forward ownership on the sustainability of upstream collusion. We consider a homogeneous Cournot duopoly with competing vertical chains, where each upstream firm has symmetric passive ownership over its downstream exclusive client. With general demand, (i) we show that passive forward ownership increases collusive profits, (ii) we identify two opposing effects of passive forward ownership on punishment and deviating profits: a positive (direct) effect due to ownership and a negative effect working through input prices. By considering three demand functions, including the widely-used linear demand, we show that passive forward ownership hinders upstream collusion.