The Economics of Investor Engagement

Institutional investors engage with their portfolio companies to communicate information and preferences. Using a discrete choice model and novel data on engagement, we find that the costs and benefits of engagement vary across funds and firms, with passive funds engaging relatively less than active funds due to their lower fees. Contrary to concerns that passive investing generates negative externalities, we find that society and investors benefit from the rise of passive investing because active funds exhibit diseconomies of scale but passive funds do not. Our results highlight a misalignment between the socially optimal and privately optimal behavior of institutional investors.