Institutional investors, which include such entities as mutual funds, hedge funds, and insurance companies, frequently own shares in firms that compete in the same industry.
This practice is known as common ownership, and it occurs in many sectors of the economy. Also known as horizontal shareholding, the practice has increased in recent years along with a growth in passive fund management, which relies on diversification within industries to minimize risk to shareholders.
One often-cited example is the airline industry, where a handful of institutional investors own significant percentages of the four major airlines that dominate the domestic market share.
Some economists are concerned about the impact of common ownership on the competition.
What Is The Controversy Regarding Common Ownership And Anti-Competitive Practices?
According to critics, common ownership can be a way to circumvent the intent of antitrust laws (read about Kelly Legal Group for more information on business law). U.S. federal and state antitrust laws seek to promote competition among corporations.
Specifically, these laws prevent companies from colluding to fix prices, rigging the bidding process for contracts, dividing up territory to eliminate competition, or monopolizing an industry. When lawsuits have broken up monopolies in the past, consumers have benefited.
In 1984, for example, the giant telephone company AT&T broke into several separate companies following an antitrust lawsuit filed by the U.S. Department of Justice. Prior to 1984, AT&T was the only phone service provider in most of the country.
Once its monopoly ended and competitors entered the long-distance phone service market, prices dropped, and the quality of services improved.
While common ownership of shares in competing businesses is not the same as the monopoly of an industry by a single company, there is nonetheless a concern that common ownership creates a new form of monopoly that has the potential to suppress competition.
Institutional investors, on the other hand, see threats to common ownership as being at odds with investment stewardship, defined as the allocation and management of assets to create long-term value for shareholders.
Investors are concerned that any initiatives to restrict common ownership, such as limiting the percentage of equity an investor can have in competing companies, would have serious negative repercussions for individual shareholders and the economy at large.
Furthermore, if institutional investors are not able to offer sufficiently diversified funds, individuals may become reluctant to invest. Some academics also argue that there is not enough evidence that common ownership has an impact on competition.
Without clear evidence of harm, they say, there is no reason to restrict the practice.
How Common Is Common Ownership?
Common ownership plays a central role in modern investing, and it has grown increasingly commonplace over the past three decades. In the early 1990s, the chance that two companies in the S&P 1500 index would have a common major shareholder was less than 20%.
Today that probability is around 90%. There is evidence of common shareholders in many industries, including technology, finance, manufacturing, construction, and transportation, to name a few.
Moreover, a handful of major institutional investors own stock in the majority of S&P 500 companies today as well as owning the majority of stock in the S&P 500 index.
The following are a few examples that illustrate the practice of common ownership of leading companies in a variety of industries:
- Vanguard and Blackrock, two institutional investors, are the largest owners of both CVS and Rite Aid.
- Kroger, Costco, and Target have the same largest shareholders.
- Apple and Microsoft have the same largest shareholders.
- JP Morgan Chase, Bank of America, and Citigroup share the same top four shareholders.
What Is The History Of Common Shareholding?
The rise of institutional investors and the practice of common ownership can be traced back to the creation of individual retirement savings accounts in the early 1980s.
These accounts brought many new individual investors into the stock market, and retirement funds needed to offer diversified portfolios that would minimize risk for small-scale investors and protect their savings.
Portfolios that combined shares of several companies in the same industry were a safer bet than stock in a single company because higher and lower performers balanced each other out.
Nowadays, portfolio diversification is fundamental to modern notions of prudent investor stewardship.
What Are The Potential Negative Outcomes Of Common Ownership?
When businesses have a single owner, they are free to compete with each other in ways that benefit customers. A retail store will lower prices, for example, to attract shoppers away from a competitor.
When two businesses have the same owner, however, there is no competition between them and thus no motivation to lower prices or improve the quality of goods and services.
Moreover, aggressive competition between firms that share common owners can be detrimental to portfolio values. Thus, when institutional investors hold significant shares in businesses that compete in the same industry, they can potentially suppress competition and keep prices as high as possible to obtain higher dividends for shareholders.
When a business has shareholders rather than individual owners, institutional investors exert a great deal of influence on the firms whose shares they own.
Thus, another concern is the fact that executive salaries depend on market performance rather than profit, which increases the impact of common ownership.
According to Bebchuk and Fried (2003), 70% of the measures that determine compensation for executives come from market performance rather than individual performance. Consequently, CEOs are highly motivated to support the interests of investors over those of customers and employees.
When multiple firms shareowners, those businesses have an incentive to maximize profits throughout the industry rather than focusing only on their own revenues.
For example, a company might limit its production in order to ensure that demand stays high in the industry. A lack of competition not only leads to higher prices for consumers, but it may also suppress wages or limit salary increases.
According to critics of horizontal shareholding, these anti-competitive practices may be contributing to the growing income inequality in the U.S. At this point, however, fears about the effects of common ownership are mainly theoretical.
What Is The Evidence Of Competition Distortion In Practice?
Despite a growing body of literature on common ownership, there is little solid evidence that the practice distorts competition.
Some studies have focused on the airline and banking industries, where there is a high concentration of ownership, and found price increases that correlate with a higher degree of common ownership.
Specifically, Azar, Schmaltz, and Tecu (2018) found that common ownership in the airline industry drove up the cost of tickets by up to 7%. However, other scholars have criticized the methods used in such studies.
They argue that there is not yet enough evidence that common ownership is actually doing harm to consumers.
In fact, proponents of common ownership point out that the majority of consumers are also investors who rely on the stock market for their retirement savings. Thus, some anti-competitive behaviors can benefit consumers as investors.
Do Any Current Antitrust Laws Prohibit Common Ownership?
Some critics of the horizontal shareholding claim that it violates The Clayton Antitrust Act of 1914.
The purpose of the act was to reinforce previous antitrust legislation, and it specifically prohibits the acquisition of stocks that would decrease competition along with any other form of collusion.
The problem with applying the law to the modern practice of common ownership is that it is difficult to prove that common shareholding results in a softening of competition.
If two or more firms signed a contract promising not to compete, or if they agreed to raise prices across the board, they would be violating antitrust laws.
But common ownership does not lead to this kind of open collusion. At this time, neither the Federal Trade Commission nor the Department of Justice sees common ownership as an antitrust violation.
Further study may provide more evidence that the practice distorts competition, but as of now, the evidence just isn’t there.
Do We Need New Legislation To Limit Anti-Competitive Behavior Resulting From Common Ownership?
While some theorists suggest that we need new antitrust laws that target common ownership, others argue that existing antitrust legislation already prohibits collusion on pricing, division of territory, and other anti-competitive tactics.
Laws that would strip institutional investors of their rights to vote and to create diversified portfolios may do more harm than good.
The millions of Americans who own shares in mutual funds depend on institutional investors to grow and protect their savings, and the benefit of diversified funds may outweigh the disadvantages of suppressed competition.
Institutional investors have a strong incentive to create long-term value for shareholders, and competition is a key factor in a thriving economy.
Thus, the largest institutional investors are the least likely to engage in intentional anti-competitive behavior. It may be worth monitoring smaller, narrowly focused portfolios where the potential and incentive for abuse may be greater.
Instead of enacting legislation based on theory, imposing penalties that could do more harm than good, we should make evidence-based decisions that take the needs of all stakeholders, including small investors, into consideration.