My forthcoming article, ‘The Conundrum of Common Ownership’, examines the phenomenon of common ownership, through a corporate governance lens. The common ownership debate has become one of the most contentious in corporate law. It is a by-product of major changes to capital-market ownership structure, which have triggered concerns about the rise of institutional investors, the growth of index investing, and the rapid concentration of ownership in major international financial markets.
Common ownership theory focuses on concerns about the incentives of large financial institutions holding widely diversified portfolios of shares in competing companies within a particular economic sector. A number of scholars (‘anti-common ownership scholars’) have argued that, even where institutional investors own relatively small ownership stakes, their collective holdings in competing companies produce anticompetitive effects. The basis for this claim is that, in such circumstances, the institutions are interested in the financial performance of their portfolios as a whole rather than the performance of individual companies in that sector. Other scholars, however, have challenged both common ownership theory and its regulatory prescriptions.
Although the common ownership debate began in the United States, it is now attracting attention around the world. European intergovernmental and regulatory organizations have focused on the debate, which also has relevance to certain jurisdictions in the Asia-Pacific region. This is particularly true of Australia, given the distinctive role and large size of superannuation/pension funds in the Australian capital markets and the concentration of certain industries, such as the banking and finance sector.
My article begins by comparing and contrasting the common ownership debate with La Porta et al’s ‘law matters’ hypothesis two decades ago. Like that hypothesis, common ownership theory originated in financial economics but subsequently emerged in legal scholarship, where it has had an equally significant impact (ie law’s discovery of an ‘economic blockbuster’). The law matters hypothesis viewed deep and liquid capital markets as a kind of corporate Holy Grail. Yet, for contemporary anti-common ownership scholars, the fact that the fund flows to today’s deep capital markets are channeled through a small number of powerful financial intermediaries, with highly diversified portfolios, represents an intractable problem requiring extreme regulatory solutions.
As the article notes, common ownership theory is linked not only to institutional investors, but also to a particular type of investment—index investing. The massive growth of index funds in recent times has led some commentators to ask whether they are now ‘eating the world’. Yet, this voracious form of investment has also become the new default investment option for major financial institutions such as BlackRock. Index investing features prominently in the literature discussing common ownership, but it is important to note that the implications of the common ownership theory are, in fact, far broader than this form of investing and include actively managed funds.
The article argues that three possible narratives underpin scholarship concerning common ownership and that the literature in the field often shifts between these narratives, without specifying which version is being applied. The three possible narratives concerning common ownership are:
- Version 1 – 'the lazy investor narrative' (which focuses on the general incentives and behavior of fund managers, and raises concerns about their lack of corporate governance engagement);
- Version 2 – 'the anticompetitive pressure model' (which argues that, where common ownership occurs within the same economic sector, institutional investors will have skewed incentives, leading them to abuse their ownership rights by pressuring managers of investee firms to act in an anticompetitive or collusive fashion); and
- Version 3 – 'the mindreading model' (which presumes that mere awareness by company managers of the existence of common ownership in their sector will lead them to identify, and cater to, the presumed anticompetitive preferences of large diversified investors).
Version 3 of these possible narratives is a startling proposition. It suggests that institutional investors that own shares in competing companies can be liable under U.S. antitrust law if their pattern of ownership lessens competition, even though they have not undertaken any positive actions to contribute to such an outcome. Indeed, Version 3 is reminiscent of Justice Louis Brandeis’ comment more than 100 years ago that ‘[t]here is no such thing…as an innocent stockholder’.
Finally, the article analyzes certain aspects of the common ownership theory in the light of contemporary corporate governance developments and debate. This discussion highlights the way in which common ownership theory subverts many fundamental contemporary tenets of good corporate governance concerning the desirability of increased shareholder engagement. Also, Versions 2 and 3 of the common ownership narrative contradict the traditional image of the institutional investor as passive and a ‘paper colossus’, since both versions presume high levels of institutional investor influence. Yet, in fact, US shareholders, including institutional investors, have far fewer statutorily guaranteed corporate governance participatory rights than shareholders in other common law jurisdictions, such as the United Kingdom and Australia.
Another problematic aspect of the common ownership theory is its focus on institutional investors, rather than in their portfolio firms. By targeting investment patterns, the common ownership theory obscures the fact that firms in some sectors, such as the technology sector, have themselves become ‘powerful megacompanies’. Furthermore, the common ownership theory is focused almost exclusively on the goal of profit maximization. It arguably ignores one of the most important developments in current international corporate governance, namely the growing importance of environmental, social and governance (ESG) practices.
Although anti-common ownership scholars often suggest that recognition of the link between concentrated ownership and antitrust law is entirely new, this is not, in fact, the case. Corporate governance scholars in the 1990s explicitly considered the growth in concentrated ownership and portfolio diversification from a competition law perspective, yet determined that antitrust law constituted a very weak constraint on institutional investors.
The article concludes that drawing regulatory and policy conclusions from the existing mixed findings in the empirical evidence is premature.
This post first appeared on the Columbia Law School Blue Sky Blog here.
Jennifer G Hill is the Bob Baxt AO Chair in Corporate and Commercial Law and director of the Centre for Commercial Law & Regulatory Studies (CLARS) in the Monash University Faculty of Law, Australia, and a Research Member of the European Corporate Governance Institute (ECGI).