We identify a novel economic mechanism through which passive ownership positively affects informational efficiency in the cross-section of firms. Passive investors’ inelastic demand lowers a firm’s cost-of-capital, inducing it to take more risk. The higher cash flow variance, in turn, incentivizes active investors to acquire more precise private information, pushing up price informativeness for firms with high passive ownership. High passive ownership also implies higher stock prices and higher stock-return variances. An increase in the aggregate size of passive investors amplifies these cross-sectional differences. We also document complementarities in firms’ real investment and investors’ information choices that can cause information crashes. Received May 31, 2020; editorial decision January 4, 2023 by Editor Holger Mueller.

We study the impact of foreign institutional investors on price efficiency with firm-level international data. Using additions to the MSCI index and the U.S. Jobs and Growth Tax Relief Reconciliation Act as exogenous shocks to foreign ownership, we show that greater foreign ownership increases stock price informativeness, especially in developed economies. This increase arises from new information that foreign investors bring in and displacement of less-informed domestic retail investors. Finally, we show that foreign ownership, particularly from active investors, increases market liquidity, reduces firms’ cost of equity, and increases firms’ real investment growth.