Monitoring spillovers between competing passive and active funds

Abstract

We examine monitoring interactions and spillovers between passive and active funds. In our model, funds use fees and monitoring capacities to compete with each other over fund flows from a set of heterogeneous risk-averse investors. We show that passive funds find positive monitoring optimal in equilibrium. We provide conditions for when passive and active fund monitoring are strategic complements, leading to monitoring of the same firms, or strategic substitutes, leading to monitoring of different firms. Additional results speak to the corporate governance implications of restrictions on passive or active shareholder voting and limits on disclosure of active fund portfolios.