Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency

Abstract

We study the joint portfolio and information choice problem of institutional investors who are concerned about their performance relative to a benchmark. Benchmarking influences information choices through two distinct economic mechanisms. First, benchmarking reduces the number of shares in investors' portfolios that are sensitive to private information. Second, benchmarking limits investors' willingness to speculate. Both effects imply a decline in the value of private information. Hence, in equilibrium, investors acquire less information and informational efficiency declines. As a result, return volatility increases and benchmarking can cause a decline in equilibrium stock prices. Moreover, less-benchmarked institutional investors outperform more-benchmarked ones.

Keywords: benchmarking, institutional investors, informational efficiency, asset allocation, asset pricing

JEL Classification: G11, G14, G23