The Economics of Investor Engagement

Why do institutional investors engage with their portfolio companies? We develop a discrete-choice model of engagement and estimate it using hand-collected data on investor–firm interactions to recover the costs and benefits of engagement. Financial incentives, not reputation or marketing, drive most engagement decisions: investors behave as if spending $10,000 on engagement raises firm value by 0.3 to 0.4 basis points, and by 3 to 7 basis points at small firms. Yet investors capture only part of this and so engage less than the shareholder-value-maximizing level. Investors engage relatively less with small firms, because smaller holdings reduce the dollar return to engagement. Passive investors engage less than active investors because their lower fees reduce the value they capture. Counterfactual simulations show that the effect of rising passive ownership depends on how it grows: if passive assets grow because active managers exit rather than shrink proportionally, aggregate value creation declines.