Does the rise of index funds make managers myopic?

The short-term thinking of business managers is a real problem. We know that when managers focus too much on managing quarterly earnings results, they can lead a company astray reduce profits in the long run. Indeed, one survey among 400 executives in 2005 found that about 78% of executives would destroy economic value in exchange for smooth earnings.

Twenty years have passed since then, and the question of whether companies should report earnings quarterly or less frequently remains unresolved. But since then we’ve seen two things change. Corporate earnings calls have become more common and frequent, and index funds have become a larger part of the market.

This made one team from the University of Washington I wonder if managers’ short-termism has worsened over time, and if so, whether this has been caused by the rise of price-insensitive buyers (i.e. index funds).

To test this, they invited 47 experienced business managers with an average of 26 years of experience in finance or accounting into a laboratory and asked them to choose between different business strategies. One strategy (Strategy A) has less predictable profits, but is expected to produce greater long-term returns. The other strategy (Strategy B) produces more predictable profits in the short term, but will likely lead to smaller total returns. Strategy B is therefore a short-sighted strategy that aims to equalize profits from quarter to quarter.

The participants were grouped along a 2×2 arrangement. They either ran a company with 10% index fund ownership (low index fund ownership) or 40% index fund ownership (high ownership). And they were told that the company they worked for had provided earnings guidance every quarter for the past three years, or had provided guidance only once in the previous three years.

Here is a graph showing what proportion of participants in the lab chose the short-sighted Strategy B.

Share of managers who opt for a short-term strategy

Source: Kamrath et al. (2025)

Regardless of the degree of ownership of index funds, managers who work at companies that provide more frequent earnings forecasts make more short-sighted decisions. Their motivation is to keep investors happy by keeping them in line from quarter to quarter and hitting targets every three months, even at the expense of longer-term earnings growth.

The other thing they found is that managers who work at companies that have a higher share of index fund investors also tend to become more myopic in their strategy, but only if they work at a company that has provided more guidance in the past.

This has less to do with the rise of index funds than with index funds replacing long-term shareholders on the register. With fewer long-term shareholders, a company’s managers have greater incentive to keep the company in an index so that the index trackers don’t sell the shares. And keeping the stock price high requires predictable, smooth profits. They therefore become more short-sighted and also focus on quarterly guidance.