Assistant Professor of Finance Ian Appel is the co-winner of a research competition for his jointly authored paper challenging the idea that so-called passive investors wield little influence in the marketplace.
Appel, along with Wharton School of Business faculty members Todd Gormley and Donald Keim, were recognized by the Investor Responsibility Research Center Institute (IRRCI), which said their work “has the potential to reshape investor thinking.” The paper is forthcoming in The Journal of Financial Economics.
Titled “Passive Investors, Not Passive Owners,” the paper reveals how passive investors – those who typically manage index funds – aren’t really passive at all and in fact are more active behind the scenes.
“When we think about investors who influence different corporate policies, we usually are talking about the Carl Icahns of the world and activist hedge funds,” says Appel, who joined the Carroll School of Management last September. “The message of our paper is that influence is not just limited to them. Passive investors – the Vanguards and State Streets – also have influence over how companies are run.
“Our findings contradict the perception that passive investors, who hold a large basket of stocks and attempt to track a benchmark index like the S&P 500, only care about tracking errors and keeping fees low. That’s not the case at all.”
Appel and his co-authors found that passively managed mutual funds, and the institutions that offer them, use their large voting blocs to exert influence on firms’ governance.
“By owning shares, they have a fiduciary responsibility to their investors to vote in their best interests,” says Appel. “That’s one reason why you may think they might make a difference and have an effect on the firms they own.”
Appel says an investor doesn’t necessarily have to make a lot of noise to be heard; significant ownership of shares will do it.
“If you own a large share of a company, say 5 percent, and you call up the management, they’ll take your call. And if you say, ‘These are the things we care about, these are the changes we’d like to see made in companies,’ they may be more inclined to listen to you when you own a big chunk of shares and they know you’re not going to sell off those shares any time soon.”
That influence can lead to governance changes such as more independent directors on corporate boards, removal of takeover defenses and more equal voting rights.
“Our evidence suggests they successfully influence firms’ governance choices in ways that improve long-term, firm-level performance,” says Appel. “Vanguard talks about how they send a letter to many of their portfolio companies where they outline what they consider to be important aspects of corporate governance, and how companies are run.”
Appel says the validity of the research was underscored when the comptroller of New York City – who oversees the city’s pension funds – spoke at the IRRCI conference where the award was presented.
“He said, ‘Listen we own pretty much every stock, and at the same time, we’re activist. We go and talk to companies, if they’re doing something we don’t like, we tell them about it.’”
Appel says he and his co-authors, who spent more than two years on the research, says the honor is a meaningful one. “To get recognition from practitioners in the finance world and also from experts in other fields who helped with the judging is really gratifying.”
By Sean Hennessy | News & Public Affairs