N°25-105: Passive Investors and Loan Spreads

Over the past decades, index funds have amassed substantial ownership stakes in publicly traded firms, which raises questions about their influence on governance and monitoring. This paper examines how banks adjust their loan pricing when firms have a higher share of passive index fund investors as shareholders. Using syndicated loan data, we find that loan spreads increase with passive ownership, and provide evidence consistent with higher loan spreads reflecting increased risk due to reduced shareholder oversight. Supporting this interpretation, we find stronger effects among well-governed and informationally opaque firms, where shareholder oversight is more impactful. However, the increase in loan spreads is not fully accounted for by changes in traditional measures of firm risk. Suggestive evidence points towards banks increasing their monitoring intensity in response to changes in shareholder composition, which is costly and reflected in loan spreads.