In our recent article titled “Common Ownership and Hedge Fund Activism: An Unholy Alliance?” we propose a novel mechanism linking common ownership to anticompetitive outcomes. While hedge fund activism can be beneficial to society in a competitive market, we highlight a symbiotic relationship between common owners and activist hedge funds that may be detrimental to society.

In our model, multiple firms face the decision to invest in new projects or increase payouts to shareholders. Investment requires resources, acquired in a competitive market—with labor being the primary resource of focus. The firm’s governance structure, initially set by shareholders, determines control over investment decisions. In a “weak” governance structure, like dual-class firms with outside shareholders owning non-voting shares, managers are shielded from shareholder discipline, and investment decisions rest with the manager. Disloyal managers may either overinvest (e.g., “empire-building” aspirations) or underinvest (e.g., “quiet life” motives) relative to the shareholder value-maximizing policies. The nature and severity of these “agent costs” vary across firms. A “strong” governance structure, found in firms without staggered boards and poison pills, enables shareholders to hold managers accountable through the empowerment of hedge fund activism. While activist interventions alleviate agent costs, they also impose non-trivial “principal costs,” stemming from their potential mistakes or conflicts with other shareholders. These principal costs manifest as excessive pressure on managers to increase payouts which inevitably leads to missed profitable investment opportunities. A stronger governance structure may either boost or diminish a firm’s investment and share value in our framework.

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