Paul Borochin is Assistant Professor at the University of Connecticut School of Business. This post is based on a recent paper, authored by Professor Borochin; Jie Yang, Senior Economist at the Board of Governors of the Federal Reserve System; and Rongrong Zhang, Associate Professor at Georgia Southern University College of Business.
Related research from the Program on Corporate Governance includes New Evidence, Proofs, and Legal Theories on Horizontal Shareholding by Einer Elhauge (discussed on the Forum here). The views in the post are solely those of the authors and do not necessarily reflect those of the Federal Reserve System.
In common ownership, the type of the common owner institution matters. Institutional ownership of firms has seen a marked rise in the past few decades, with average institutional ownership share of a firm rising from 20% to 30% in the 1980s to over 65% of the total by the 2010s, with residual retail ownership correspondingly falling from 80% to less than 35% of the firm. (See Borochin, Paul, and Jie Yang (2017). The Effects of Institutional Investor Objectives on Firm Valuation and Governance, Journal of Financial Economics 126.) Over the same period, the fraction of the average firm held by institutions holding blocks of same-industry rivals has risen from 4.5% to 28%. (See He, Jie, J. Huang, 2017, Product Market Competition in a World of Cross Ownership: Evidence from Institutional Blockholdings, The Review of Financial Studies 30.) This not only changes the portfolio properties of the institutional investors, but also has the potential to change the corporate strategies of held firms. Recent studies find opposing effects of common institutional ownership on the competitive behavior of firms:
On the one hand, Elhauge (2016) and Azar, Schmalz, and Tecu (2018) propose an alternative benefit stemming from changes in firm competitive behavior: common ownership of same-industry firms incentivizes both investors and managers to maximize portfolio rather than firm profits leading to anti-competitive outcomes. (See Elhauge, E., 2016, Horizontal Shareholding, Harvard Law Review 129 discussed on the Forum here, and Azar, J., M. Schmalz, I. Tecu, 2018, Anti-competitive Effects of Common Ownership, Journal of Finance 74.) On the other, He and Huang (2017) argue that common institutional ownership can facilitate collaboration between firms by resolving incomplete contracting issues, and directly or indirectly facilitate information sharing between same-industry rivals. (He, Jie, J. Huang, 2017, Product Market Competition in a World of Cross Ownership: Evidence from Institutional Blockholdings, The Review of Financial Studies 30, discussed on the Forum here) In our paper, we seek to reconcile these findings by documenting countervailing effects of common ownership by institutional type.
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