As the passive investing strategy has taken the market by storm, criticism of index funds and common ownership have increased: Are index funds evil (as asked by The Atlantic)? Are they bad for the economy?
Common ownership came under fire last year with a study finding that “airlines compete less vigorously on price because they are owned by the same handful of investors,” writes David Nicklaus.
However, in an interview with The St. Louis Post-Dispatch, Olin’s Todd Gormley, associate professor of finance, provides a defense for companies with higher index-fund ownership: They actually have better governance.
An active money manager who doesn’t like the way a company is run can simply sell the shares. The passive manager doesn’t have that choice. “In their view, the only way they can protect themselves is to make sure there are good governance structures in place,” Gormley said.
Besides, he said, long-term passive investors often back activist hedge funds that attempt to shake up a company. “We found a positive influence on governance,” Gormley said. “The presence of these index funds makes it easier for other investors, the activists, to get into a company and provide discipline over management.”
Gormley was recently quoted in the Princeton Alumni Weekly on the same subject, where he discusses the evidence of some positive effects of passive ownership.