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E-MailScott Hemphill is Moses H. Grossman Professor of Law and Marcel Kahan is George T. Lowy Professor of Law at NYU School of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); New Evidence, Proofs, and Legal Theories on Horizontal Shareholding by Einer Elhauge (discussed on the Forum here); and Horizontal Shareholding by Einer Elhauge (discussed on the Forum here).
A common concentrated owner (CCO) holds stakes in competing firms. Antitrust theorists have long posited that the interests of a CCO differ from those of an owner of a single firm. Economists have developed models in which, depending on its ownership structure, a firm in a noncompetitive industry maximizes a weighted average of its own and its competitors’ profits. Specifically, greater CCO ownership induces a firm to place a greater weight on competitor profits. At the same time, greater ownership by concentrated owners who do not hold stakes in competing firms—noncommon concentrated owners, or NCOs—reduces that weight. Recent empirical work has found that an increased level of CCO ownership is associated with anticompetitive effects. Other papers find no effect. This literature has generated a heated debate about whether common ownership in noncompetitive industries is compatible with the antitrust laws and whether it should be restricted.
Thus far, the literature has focused on how a particular ownership structure affects firm behavior and outcomes. The ownership structure is taken as given. However, if ownership structure affects firm value, then we would expect owners to alter their stakes in light of this anticipated effect.
In a new paper, we endogenize the ownership choices of concentrated owners. Concentrated owners choose their stakes in light of the effects of ownership on firm behavior and firm (and competitor) profits. We analyze these choices within a simple model of competition in a duopoly where the two competing firms are owned by a mix of NCOs, CCOs, and atomized owners. Our model is highly stylized, featuring Cournot (quantity) competition between the firms and a single CCO with equal stakes in both firms. But as discussed below, it captures the general features of theories of common ownership.
We derive and characterize the level of equilibrium ownership structure. We show that an NCO, compared to an atomistic owner, places a greater value on an additional share of the firm. Hence, the NCO has an incentive to acquire shares held by atomistic owners. Likewise, a CCO with similar stakes in the firms, compared to an atomistic owner, places a greater value on an additional share. Thus, both types of concentrated owner have incentives to acquire shares held by atomistic owners.
These results follow directly from two premises underlying the theoretical literature on common ownership. The first premise is that a CCO is interested in having a firm take actions that maximize the value of its total stakes, rather than the value of its stake in that firm. The second premise is that increased ownership confers upon the owner some degree of increased control over firm decisions. A CCO uses that power to alter the firm’s decision making to maximize its total stakes, whereas an NCO uses that power to induce the firm to take actions that maximize firm value.
Our results make intuitive sense, given these premises. When an NCO buys additional shares of a firm, it obtains an increased degree of control over the firm’s decisions, which it uses to increase firm value—and hence the value of its pre‐existing stake in that firm. The NCO’s outsized incentive and opportunity to increase value lead it to place a greater value on a marginal share, compared to an atomistic owner. As for CCOs, a CCO with equal stakes in the competing firms wants to maximize industry profits. Holding a greater stake in all firms gives the CCO more control, which it uses to induce firms to take more actions that maximize industry profits. This raises the value of the CCO’s pre‐existing stakes in the competing firms, with similar implications.
The model yields three predictions. The starting point for the first prediction is that if common owners value marginal shares more than atomistic owners, then in equilibrium, CCOs and NCOs hold all of the shares. This result assumes, of course, that concentrated owners face no constraints in increasing their stakes.
In reality, concentrated holders face several constraints: they may have limited access to capital, want to reduce risk by holding diversified portfolio, or want to preserve liquidity, among other issues. Thus, while one would not expect NCOs and CCOs to completely crowd out atomistic owners, the model predicts a higher level of ownership concentration in noncompetitive industries (where firm decisions affect the value of competing firms) than in competitive industries (where such effects are largely absent).
A second prediction pertains to the portfolio structure of institutional investors. A CCO’s opportunity to earn outsized profits by changing a firm’s profit weights is limited to a subset of industries where there is a substantial opportunity to elevate price or restrict competition in other ways. Thus, one would expect institutional investors taking advantage of this strategy to be overweight in this subset, relative to more competitive industries.
Third, and related, the model predicts that an investor would concentrate in one or a few such industries, rather than all of them. That is because concentrated investments are more effective in altering a firm’s profit weights.
Bringing these latter two predictions together, one would expect an investor to be overweight in noncompetitive industries, and less diversified across noncompetitive industries compared to its diversification across competitive industries.
These predictions can be used to test the common ownership theory. It is disputed to what extent a CCO can effectively induce a firm to take actions that reduce its value but raise the value of the CCO’s other portfolio holdings. In previous work, we identified several reasons why doing so may be difficult, especially if it entails legal or reputational risks. In that work we also identified several strategies for achieving this result that seem feasible. The empirical literature to date, however, has not been able to establish whether investors in fact pursue such strategies. Part of the reason for this failure is the difficulty of structuring econometric tests that causally link certain outcomes (such as a change in prices) to ownership structure. Our article points to a different empirical approach that has the potential for producing additional evidence about the effects of common ownership.
The complete paper is available for download here.
