Print
E-MailJie (Jack) He is Associate Professor at the University of Georgia Terry College of Business and Jiekun Huang is an Assistant Professor of Finance at the College of Business at the University of Illinois Urbana-Champaign. This post is based on a recent article by Professor He and Professor Huang, forthcoming in the Review of Financial Studies.
Over the past few decades, publicly traded firms have become increasingly interconnected through common stock ownership. For example, the fraction of U.S. public firms held by institutional blockholders that simultaneously hold at least 5% of the common equity of other same-industry firms has increased from below 10% in 1980 to about 60% in 2014. This increasing trend of institutional cross-ownership of same-industry firms suggests that treating firms as independent decision-makers in the product market may no longer adequately capture real strategic interactions among them. In fact, ample anecdotal evidence suggests that large common blockholders can exert influence on the corporate decisions and product market strategies taken by their cross-held firms. Given the tremendous growth in same-industry institutional cross-ownership and the fact that such ownership is still largely unregulated (as opposed to the heavy regulations on direct same-industry ownership such as horizontal mergers), understanding the economic consequences of same-industry institutional cross-ownership, especially its implications for product market dynamics, is important for both academics and policy makers.
In our article, Product Market Competition in a World of Cross-Ownership: Evidence from Institutional Blockholdings, forthcoming in the Review of Financial Studies, we address the above research question by empirically examining the effect of institutional cross-ownership of same-industry firms on product market performance and behavior. We hypothesize that cross-ownership can offer product market benefits by fostering coordination among firms that are cross-held by the same blockholder.
A cross-holder’s objective is to maximize risk-adjusted portfolio returns. However, intense competition among its portfolio firms, especially those operating in the same industry and thus offering similar products and services, can impose negative externalities (e.g., interfirm lawsuits, advertising wars, and R&D races) on one another and reduce combined portfolio returns for the cross-holder. Consequently, the cross-holder has an incentive to make portfolio firms reduce rivalry against each other and foster implicit or explicit coordination (such as joint ventures, strategic alliances, or acquisitions) among the firms in the product market. This hypothesis predicts that firms cross-held by the same institutional blockholder should gain a competitive advantage in the product market relative to otherwise similar non-cross-held firms.
There are at least two fundamental reasons for why cross-ownership may improve the level and efficiency of collaboration between same-industry firms beyond what these firms can achieve on their own. First, due to incomplete contracting, firms considering collaboration with rivals in the same industry may be concerned about the risk of being expropriated by their counterparties. Because cross-holders’ objectives are to maximize the combined value of their portfolio holdings, they may help align the incentives of the contracting parties and mitigate frictions associated with incomplete contracting. Second, cross-holders can reduce information asymmetry among same-industry firms and facilitate the exploration of profitable collaboration opportunities. Firms in the same industry have a natural tendency to conceal proprietary information from competitors, which may lead to suboptimal levels of collaborations. Cross-holders can facilitate coordination by enhancing information sharing among competing firms, thereby improving their product market performance.
Using a comprehensive sample of U.S. public firms from 1980 through 2014, we examine the impact of institutional cross-holdings of same-industry firms on product market performance. Our multivariate OLS analysis shows that cross-held firms experience significantly higher market share growth than non-cross-held firms. This result is robust to alternative empirical specifications and is driven primarily by activist institutions. We also find that the gains in market share associated with cross-ownership translate into higher stock valuation and improved operating profits.
To address potential endogeneity concerns, we exploit a quasi-natural experiment of financial institution mergers using a difference-in-differences (DiD) approach. When two institutions merge, a firm block-held by one merging institution is likely to experience an increase in cross-ownership when one of its same-industry rivals is block-held by the other merging institution before the merger. Thus, the treatment sample consists of firms whose ownership linkages with same-industry firms are likely to increase just because of the merger. The control sample, on the other hand, consists of other block-held firms in the same institution’s portfolio that are unlikely to experience such changes. We find evidence that treatment firms, relative to control firms, experience an approximately 0.8 percentage points larger increase in annual market share growth (about 16% of its standard deviation) surrounding the institution mergers, which suggests a causal impact of cross-ownership on product market performance.
Moreover, we find that treatment firms affected by the same institution merger are significantly more likely to engage in explicit coordination (joint ventures, strategic alliances, or within-industry acquisitions) with each other than control firms do, indicating a bridge-building role played by cross-holding institutions. We also find that treatment firms experience an increase in their innovation productivity and operating profit margin relative to control firms, suggesting that cross-held firms may collaborate on their innovation activities (e.g., by sharing technological know-how and other R&D resources) and may coordinate their product market strategies implicitly by cutting production and distribution costs (e.g., via collective bargaining against major suppliers and/or reducing marketing campaigns directly against each other). Overall, these results suggest that cross-ownership by institutional blockholders facilitates product market coordination.
Our paper is the first firm-level study that examines the implications of institutional cross-ownership for firms’ product market behavior and performance. Our findings that cross-ownership facilitates collaboration and improves product market performance carry important policy implications. While regulators are rightly concerned about potential anticompetitive effects in some industries, the regulatory framework should be designed so as not to discourage efficiency-improving collaborations in other industries.
The complete article is available for download here.
