Passive Institutional Ownership and the Informational Efficiency of Stock Prices

We examine how passive institutional ownership affects the informational efficiency of stock prices. Because passive institutional investors prefer greater transparency, their presence encourages managers to enhance firm disclosure (Boone & White, 2015; Schoenfeld, 2017). Increased disclosure improves the information environment and reduces information uncertainty, leading to lower post-earnings announcement drift (PEAD) and greater price efficiency (Hung et al., 2015; Zhang, 2006). Accordingly, we predict that higher passive institutional ownership strengthens the contemporaneous market response to earnings announcements while mitigating PEAD. Using firm additions to the S&P 500 index as an exogenous shock, we document that increases in passive institutional ownership lead to greater firm disclosure. Consistent with our prediction, we find higher earnings response coefficients (ERC) and weaker PEAD among firms with greater passive institutional ownership. Decomposing earnings into firm-specific and systematic components, we further show that the higher ERC and weaker PEAD arise from the timely incorporation of both components into prices. Our findings contribute to the ongoing debate on whether the rise of passive investing enhances or impairs price efficiency.