The benchmark inclusion subsidy

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...

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Bibliographic Details
Published in:Journal of financial economics 2021-11, Vol.142 (2), p.756-774
Main Authors: Kashyap, Anil K, Kovrijnykh, Natalia, Li, Jian, Pavlova, Anna
Format: Article
Language:English
Subjects:
Asset management
Benchmark
Benchmarks
Demand
Government subsidies
Investment
Mergers
Project valuation
Studies
Subsidies
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Summary: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.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2021.04.021