Passive Exit

Abstract

Share lending allows passive investors to generate revenue from a decline in portfolio value. When an active mutual fund exits a portfolio firm, passive index funds belonging to the same fund family raise the cost of borrowing the firm’s shares for short selling. To identify supply-side shifts, I exploit changes in the identity of active managers exogenous to within-portfolio variation in the informational sensitivity of share lending costs. The exercise of market power is pronounced in value lending programs targeting hard-to-borrow securities. Share lenders with market power capture most of the surplus arising from the price decline.