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E-MailKatharina Lewellen is Associate Professor of Business Administration at Dartmouth College Tuck School of Business, and Michelle Lowry is TD Bank Endowed Professor at Drexel University LeBow College of Business. This post is based on their recent paper, forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here); and Horizontal Shareholding by Einer Elhauge (discussed on the Forum here).
In recent years, academics and regulators have raised concerns about the high levels of common ownership within U.S. firms. The argument is that common owners—that is, investors holding stakes in multiple firms within a single industry—have incentives to discourage competition among industry rivals in their portfolios. Common ownership has increased steadily over the past few decades, fueled by the rise in institutional ownership and the emergence of large and highly diversified institutional investors. Whereas only 17% of S&P 500 firms had a blockholder that also owned a block in a competitor firm in 1990, this fraction increased to 81% by the end of 2015.
A growing number of academic studies conclude that the rise in common ownership has indeed caused cooperation among firms to increase and competition to decrease. This evidence led to several prominent policy proposals to regulate or limit common ownership. However, empirical testing of the effects of common ownership is challenging as ownership and firm behavior could correlate for many reasons even in the absence of a causal link. In this paper, we evaluate the empirical approaches used in prior literature to identify the effects of common ownership. With a more thorough understanding of the advantages and shortcomings of each approach, we then revisit the conclusions of prior empirical studies that common ownership affects firm behavior.
The general approach in the literature has been to identify exogenous shifts in common ownership and investigate whether they are followed by changes in firms’ strategy or performance. Researchers have focused on three types of events that would cause shifts in common ownership: mergers between financial institutions, firms’ entry into the S&P 500, and Russell index reconstitutions. The merger events are especially interesting because, unlike index additions, they are unlikely motivated by the portfolio firms’ policies or performance. Moreover, mergers can cause sharp increases in common ownership of firms held by the different merger partners. To provide a simple example, if each merger partner owned one firm in an industry, the new merged financial institution would by definition own both firms. If this institution discourages competition between its newly cross-owned firms, we should observe that the firms’ behavior changes after the merger event.
Prior literature shows that firms expected to experience such exogenous jumps in common ownership (“treated firms”) appear to compete less and / or cooperate more after the mergers (for example, they improve their financial performance and scale back investment relative to control firms). We confirm these results in our data, but we uncover a flaw with the causal interpretation. The issue is simple: while the merger sample includes over 60 events scattered across multiple decades, the resulting list of the “treated firms” is dominated by one large merger—that of BlackRock and BGI. This event occurred in 2009 and, thus, coincided with the aftermath of the financial crisis. It turns out that this overlap, combined with the fact that the treatment sample is tilted towards growth firms, causes the tests to produce misleading results. After modifying the tests to account for the bias, we find no evidence that the financial institution mergers caused subsequent changes in firm decision making or performance. For example, firms with similar characteristics as the treated firms also show relative increases in profitability around the financial crisis, even though their cross-ownership has not changed.
We also examine the two alternative approaches used to identify shifts in common ownership, the S&P 500 additions and Russell reconstitutions, and we find that both present serious challenges. For example, the Russell reconstitutions do not cause sufficiently strong shifts in common ownership on the institutional level to cause measurable effects on firm behavior. This suggests that any observed effects are likely due to other factors. Overall, we conclude that, in spite of the large number of studies in this area, there is, thus far, little robust evidence that common ownership has had significant effects on firms’ behavior.
The full paper can be found here.
