ARTICLES INDEX FUNDS AND THE FUTURE OF CORPORATE GOVERNANCE: THEORY, EVIDENCE, AND POLICY by Lucian Bebchuk & Scott Hirst

ARTICLES INDEX FUNDS AND THE FUTURE OF CORPORATE GOVERNANCE: THEORY, EVIDENCE, AND POLICY by Lucian Bebchuk & Scott Hirst

I. AN AGENCY-COSTS THEORY OF INDEX FUND STEWARDSHIP
This Part develops our agency-costs theory of index fund 
stewardship. We start by explaining the nature of index funds and the 
stewardship activities they undertake in section I.A. We describe views 
that have been expressed about the significant promise that the nature of 
index funds holds for stewardship in section I.B. We explain that this is 
the basis for the “value-maximization view” of index fund stewardship, 
and we put forward our competing “agency-costs” view in section I.C. We 
then develop the agency-costs view, showing how this view indicates that 
index fund managers will have incentives to underinvest in stewardship 
in section I.D, as well as incentives to be excessively deferential to 
managers of portfolio companies in section I.E. Finally, we consider two 
potential limits—arising from fiduciary norms and reputational 
considerations—on the force of these incentives in section I.F. 
A. Index Funds and Stewardship 
1. Index Funds. — Index funds are a special type of investment fund. 
Investment funds pool the assets of many individuals and entities and 
invest those assets in diversified portfolios of securities. Actively managed 
investment funds buy and sell securities of companies in accordance with

their views about whether those companies are under- or overvalued. By 
contrast, index funds invest in portfolios that attempt to track the 
performance of specified benchmark indexes, such as the S&P 500 or the 
Russell 3000. The term “index fund” encompasses both mutual funds 
and exchange traded funds (ETFs), or any other investment vehicle that 
mechanically tracks an index. Well-known examples of index funds 
include the Vanguard S&P 500 Mutual Fund, SSGA’s SPDR S&P 500 
ETF, and BlackRock’s iShares Core S&P 500 ETF. While some index 
funds also track indexes of debt securities, this Article focuses on those 
that invest in equity securities. 
As we analyze in detail in our recent empirical study, The Specter of the 
Giant Three, the index fund sector is heavily concentrated and is 
dominated by the Big Three. In that study we explain that such 
concentration is to be expected and should be expected to persist. The 
dominant incumbents have significant structural advantages that derive 
from the economies of scale of operating index funds; the funds’ 
branding; and—in the case of ETFs—the liquidity benefits for funds with 
large asset bases. In addition, there are no significant opportunities for 
new entrants to attract business from the incumbents by introducing new 
products that would be difficult for the incumbents to imitate.
2. Stewardship. — In the literature on institutional investors, stewards-

hip refers to the actions that investment managers can take in order to 
enhance the value of the companies that they invest in on behalf of their

ARTICLES INDEX FUNDS AND THE FUTURE OF CORPORATE GOVERNANCE: THEORY, EVIDENCE, AND POLICY by Lucian Bebchuk & Scott Hirst