Increasing Market Power through Common Ownership

Hands remove two slices from a pie

The increase in common ownership is one of the many trends observed among firms in the last years. Common ownership creates an incentive to pay more attention to how other firms in the same industry are doing, given the investors’ interests. In Barcelona School of Economics Working Paper 1371, “Ownership Diversification and Product Market Pricing Incentives,” Albert Banal-Estañol, Jo Seldeslachts, and Xavier Vives investigate these common-ownership incentives to disentangle the role of passive and active investors in shaping them, and their ultimate impact on market power.

What kind of investors are around matters for incentives

It is usual to think of firms in the economy as maximizing their profits, keeping in mind that dividends are paid to investors or shareholders. In recent years, investors have been acquiring simultaneous interests in multiple firms, a fact that is known as common ownership. Because of this, firms want to pay increasing attention to how other firms in the industry are doing, and to their profits, since investors tend to have related investments across firms.

However, not all investors are alike. The authors stress the importance of one classification: passive investors vs. active investors. The former are usually interested in keeping a diversified portfolio across firms to track some market index. In contrast, the latter are usually more exposed to  a particular firm or industry. Thus, active investors are less diversified than passive ones. Figure 1 shows that passive investors are more diversified, than active investors.

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Figure 1. Investor Diversification Levels. Passive Investors (blue) vs. Active Investors (red)

Hence, firms might be more interested in paying attention to other firms’ profits in the same industry to the extent that passive investors hold a larger share of that firm and even more so if those investors control a larger share of it.

The increasing importance of passive investors

In a nutshell, passive investors have grown in importance after the financial crisis. This is attributed to lower costs, superior returns after fees, and tax advantages, as compared to active investment. Figure 2 shows that passive investors have increased their company holdings relative to active investors in the past years, especially since the financial crisis.

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Figure 2. Relative level of holdings of passive relative to active investors

The authors find evidence that indicates that the increase in the average common ownership incentives measures can indeed be linked to this increase in the relative holdings of passive investors. Further the increase in passive investment is exogeneous to the performance of specific firms or industries.

Common ownership has also influenced firms’ markups

The increased attention that firms pay to the profits and actions of other participants in their same industry (i.e., the common-ownership incentives) seems to follow closely the increase in firms’ markups that have been documented in the last years, as depicted in Figure 3.

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Figure 3. Structurally estimated markups for US publicly-listed companies

Theoretically, an increase in the levels of common ownership between a firm and its competitors makes price increases in a firm’s products less damaging for investors. This is because they can compensate for these losses by the diverted sales, and the associated profits, that other commonly owned firms get.

The authors test several regression specifications and find consistent evidence of a positive and significant relationship between their measure of common ownership and firm-level markups, confirming the patterns that seem to exist in the data. Combining it with the evidence on the causes of common ownership, the authors argue that firms’ markups can be linked to the relative holdings of its passive investors, through the firm’s common ownership incentives.

In sum, the paper points towards a linkage between common ownership and firms’ markups. This can be due to price effects or a related cost reduction across commonly owned firms. However, there is still work to be done to disentangle whether common ownership is anti- or pro-competitive, which is of paramount importance to regulators for understanding the ultimate effects of a phenomenon of increasing importance in product markets.