The Role of Index Fund Ownership in the Era of Say‐on‐Pay

ABSTRACT We examine whether and how index funds influence executive compensation in the post‐Say‐on‐Pay era. Using the annual reconstitution of the Russell indexes as a source of exogenous variation in index fund ownership, we document a causal effect of index ownership on CEO pay structure. Firms with greater index ownership adopt more performance‐vesting and equity‐based compensation, consistent with preferences expressed by institutional investors and proxy advisors. These effects emerge only after the implementation of the Say‐on‐Pay rule, suggesting a voting‐enabled mechanism. Further analysis reveals that index funds are more likely to vote in line with Institutional Shareholder Services, particularly when pay practices are problematic, and that failed Say‐on‐Pay votes lead to revisions in compensation structure. We also find stronger pay‐for‐performance sensitivity following index ownership shocks. Our findings highlight a scalable governance channel through which index funds, despite their passive mandates, actively shape executive incentives via proxy voting.