There is a growing sense among academics and practitioners that common ownership—where two firms are at least partially owned by the same investor—is on the rise among publicly-held U.S. firms and that this could have important implications for acquisitions, executive pay, governance, among numerous other outcomes. Such common ownership might affect firms’ strategic choices since common owners have an incentive to internalize how each firm’s actions will affect the value of other firms in the portfolio. This observation has led some to argue that common ownership by institutions may contribute to anticompetitive behavior by firms (eg, Azar and others, 2016, forthcoming) and that legal and regulatory actions are needed to limit institutions’ ability to offer index funds and hold significant stakes in some industries (eg, Posner and others, 2016).
Despite the recent attention such common ownership has received, there is little discussion of when, if at all, managers will have an incentive to internalize the preferences of common investors, and more importantly, how one should quantify the extent to which common ownership affects managers’ incentives. For example, while there is a sense that the rise of common ownership is driven in part by the merger of asset managers and the increasing popularity of index investing, there is little discussion of whether we should expect such mergers and index-induced overlapping ownership structures to increase managers’ motives to internalize how their actions might affect the value of other firms. If index fund investors or asset managers with larger, more diversified holdings are less informed or attentive to firm-specific actions, then managers would have little incentive to internalize the impact of their actions on the holdings of such investors. In a recent paper, we attempt to fill this void by quantifying the extent to which common owners shift managerial incentives.
We derive a model-based measure of common ownership that quantifies how overlapping ownership structures influence managerial incentives in a setting where not all investors are fully attentive. The resulting model-driven measure is simple and has some appealing properties. In particular, our model shows that the impact of each common investor on managerial incentives will be the product of three inputs: the extent to which the manager cares about that investor’s preferences (which is proportional to the investor’s ownership stake), the importance that investor places on the externality (which is proportional to their ownership stake in the other firm), and the likelihood that investor is informed about whether the manager’s actions have improved the value of their overall portfolio (which, among other things, is related to the importance of the firm in the investor’s portfolio). Intuitively, our measure predicts that investors that are less affected by the externality or less attentive to firm-specific policy choices should not contribute as much to managers’ incentives to internalize how their choices affect other firms.
A key feature of our measure is that it accounts for the possibility that not all investors are attentive. This differs from other measures of common ownership, which implicitly assume that all investors are fully informed about the externalities that firms impose on each other (eg, see the MHHI measure that was developed by Bresnahan and Salop (1986) and O'Brien and Salop (2000) and implemented by Azar and others, forthcoming). Our model-driven measure also differs from existing measures of common ownership in that it is invariant to the specific nature of externalities; it is best seen as a relative measure of how important common ownership is for manager incentives per unit of externality. Therefore, one can use our measure to study the effects of common ownership in a wider range of contexts.
We then take our measure to the data to illustrate the importance of accounting for investor attention. We find that the rise of common ownership may be far less important than claimed and that assumed drivers of its rise may have little impact on managerial incentives. Specifically, assuming all investors are fully informed can lead to estimates regarding the increase in managers’ incentives to internalize externalities over the last 30+ years that are orders of magnitude more than when one allows for the possibility that not all investors are attentive. Moreover, we find that managerial motives to internalize externalities can actually be lower following asset manager mergers once one accounts for possible shifts in investor attention. Specifically, our estimate suggests that nearly half of stock-pairs would experience a decline in incentives to internalize externalities following the merger of Barclays Global Investors and Blackrock in 2009. This occurs because some stocks become less important in the larger, more diversified portfolio of the merged entity, which can reduce the likelihood the larger common investor is as attentive as the two previously unmerged common investors. Finally, while ownership overlap for a stock pair increases, on average, when both firms are in the same index, we find that managers’ incentive to internalize externalities actually decreases in many circumstances. Indeed, if index investing reduces the importance of each stock in investors’ overall portfolios, it has the potential to decrease investors’ attention to whether managers are taking actions to improve the overall value of their increasingly diverse portfolios. These findings highlight that ownership overlap is a necessary but insufficient condition for shifting managerial incentives.
Overall, our findings provide important context for recent empirical and theoretical work that has suggested common ownership is important for competitiveness, corporate governance, firm outcomes, etc. We show that accounting for investor attention can have important implications for the impact of overlapping ownership structures on managerial incentives, and hence, possible policy responses.
Erik P. Gilje is an Assistant Professor of Finance at The Wharton School of the University of Pennsylvania
Todd A. Gormley is an Associate Professor of Finance at the Olin Business School, Washington University in St. Louis
Doron Levit is an Assistant Professor of Finance at The Wharton School of the University of Pennsylvania