In recent years, securities lending—making shares available for borrowing by short sellers who
“sell first and buy later”—has been an object of increasing regulatory attention. Securities lending
is linked to the growth of passive investing because large, buy-and-hold passive investors
are among the largest lenders of portfolio securities. But relatively little is understood about the
relationship between securities lending and passive investing. In this Article, I show how securities
lending allows passive investors to generate revenue from a decline in the value of their
investment portfolios in addition to borrowing fees determined by demand from the market. I
find that when an active mutual fund exits a portfolio firm, passive index funds belonging to
the same fund family raise the cost of borrowing the firm’s shares for short selling. To identify
these supply-side shifts, I exploit changes in the identity of active managers which are likely to
be uncorrelated with information that would otherwise drive within-portfolio variation in share
lending costs. I find that the exercise of market power is pronounced in value lending programs
targeting hard-to-borrow securities. Share lenders with market power capture most of the surplus
arising from price declines.