Working Paper: NBER ID: w25337
Authors: Anil K. Kashyap; Natalia Kovrijnykh; Jian Li; Anna Pavlova
Abstract: We argue that the pervasive practice of evaluating portfolio managers relative to a benchmark has real effects. Benchmarking generates additional, inelastic demand for assets inside the benchmark. This leads to a “benchmark inclusion subsidy:” a firm inside the benchmark values an investment project more than the one outside. The same wedge arises for valuing M&A, spinoffs, and IPOs. This overturns the proposition that an investment’s value is independent of the entity considering it. We describe the characteristics that determine the subsidy, quantify its size (which could be large), and identify empirical work supporting our model’s predictions.
Keywords: No keywords provided
JEL Codes: G12; G23; G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Firms included in a benchmark (L25) | Receive a subsidy (H20) |
| Receive a subsidy (H20) | Value investment projects more favorably (G31) |
| Value investment projects more favorably (G31) | Accept projects with lower mean returns or higher variances (G11) |
| Inelastic demand for benchmark stocks (D12) | Dampens adverse effects of cash flow variance on stock prices (G32) |
| Projects positively correlated with benchmark's existing assets (G19) | Larger subsidy (H23) |
| Subsidy size (H23) | Estimated at 94 basis points (G12) |