Debt Issuance in the Era of Passive Investment

Passive bond funds provide predictable demand for newly issued corporate bonds included in popular indices. By issuing index-eligible bonds, firms can take advantage of this passive demand and improve bond characteristics unrelated to index eligibility. We find that higher passive demand increases firms' propensity to issue bonds, and results in larger bonds, lower spreads, longer maturities, and fewer covenants. Firms issue a disproportionate number of bonds with face value just sufficient to be included in major bond indices. Following an increase in the index size threshold, some firms withdraw from the bond market while others respond by issuing larger bonds.