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Academics Say Rise of Index Fund Investing Poses Challenges for Corporate Governance

Two professors in an opinion piece for the Wall Street Journal write that the popularity of passive investing holds negative implications for corporate governance. The authors suggest that index funds may be hesitant to devote resources to monitoring corporate governance of the companies they invest in since any amount spent on a particular company would also benefit rivals investing in the same stock. The authors also observe that, while institutional investors like Vanguard, State Street and BlackRock may want their portfolio companies to be well run, they may not want to pay higher fees for monitoring or governance. The authors see potential negative effects if “one-size-fits-all governance solutions” are applied across vastly different companies. They propose three areas in which the law can ensure that institutional investors make informed decisions about corporate governance: relying on corporate governance experts; creating in-house governance teams that make recommendations to a fund’s managers; and encouraging passive institutional investors to abstain from voting altogether. Vanguard Chairman and CEO Bill McNabb in a response to the authors’ commentary contended that index fund managers care about corporate governance and rejected the suggestion that index funds abstain from voting as “irresponsible and ill-informed.”