The Price Isn't Right: The Effect of Passive Ownership on Stock Price Informativeness

Abstract

This paper analyzes the impact of passive investing on price informativeness by comparing how well market prices predict future profit levels for firms with high and low levels of active mutual fund ownership by constructing cross-sectional forecasting regressions of future profits on current market valuations. I find that firms with high amounts of active ownership display greater informational content in their prices from 1990--2009 in terms of predicting variation in future profits. Moreover, the magnitude of this incremental informativeness is larger when comparing firms with comparatively higher and lower levels of active ownership. This result is robust to using different metrics for the measure of profitability as the dependent variable, as well as across forecasting ranges of one to five years. However, the magnitude of the incremental information contained in prices of firms with high amounts of active ownership has decreased over this time period. While theory would predict that the higher price informativeness in firms with high active ownership would extend to real investment decisions, I find empirical evidence that suggests this channel is weak.