Passive Ownership and Market Selection: Evidence from U.S. Zombie Companies
Abstract: This paper examines how passive institutional ownership affects the survival of financially distressed firms among publicly listed U.S. companies over the period 1990 to 2024. Exploiting idiosyncratic capital flows to the "Big Three" asset managers within a Granular Instrumental Variable framework, I find that passive ownership causally increases zombie incidence and prolongs zombie spells. The mechanism operates through an asymmetric governance channel: passive investors reduce poison pill adoption through standardized proxy voting, while failing to prevent golden parachutes and supermajority requirements from accumulating, provisions that require firm-specific engagement to resist. Shielded from removal threats, managers default to the quiet life, generating a causal decline in revenue productivity of approximately 2.6% per percentage point increase in passive ownership, confirmed by a null effect on markups. These findings reveal a structural paradox: the institutional shift that democratized investing has simultaneously weakened the disciplinary function of equity ownership, distorting market selection and impeding the reallocation of resources toward more productive uses.