Benchmarking distorts investment decisions, creating unfair advantages for select firms.
Benchmarking in the financial world affects how investments are valued, creating a subsidy for firms included in the benchmark. This means that companies inside the benchmark value investment projects more than those outside, impacting decisions on mergers, spinoffs, and IPOs. The value of an investment is not solely based on its merits but also on whether it is part of the benchmark. The size of this subsidy can be significant, and there is evidence supporting this model's predictions.