Common ownership in the U.S. economy
Large investment management companies such as BlackRock Inc., The Vanguard Group Inc., and Fidelity Investments—each with tens of trillions of dollars of assets under management—offer a wide array of mutual and index funds and other diversified investments that provide a valuable product to investors. Because investment decisions are delegated to professional asset managers or the funds mirror the composition of broad indices or specific industries, these products offer a cost-effective way for retail investors to diversify their wealth.
In our latest research, we show that this diversification may come with a hidden price tag for consumers and the broader U.S. economy. It might be undermining competition across the U.S. economy, resulting in higher prices for average consumers.
The intuition is straightforward. Suppose that firms make supply or pricing decisions with the objective of maximizing shareholder value. Consider, then, a mutual fund invested in the automotive industry that happens to be the largest stockholder of Ford Motor Co., General Motors Co., Toyota Motor Corp., and Volkswagen AG. Would this mutual fund be better off if these four companies competed aggressively? Clearly not. By competing aggressively, the companies would be trying to maximize their own profits but eroding the portfolio profits earned by their shareholders.
The canonical assumption adopted by both microeconomists and macroeconomists (like ourselves) is that firms act to maximize their own individual profits as opposed to shareholder value. While in everyday parlance, we tend to use these two concepts interchangeably, the example above clearly demonstrates how, in the presence of common ownership—an ownership arrangement in which large investors own shares in several firms that compete with each other—these two alternative assumptions will produce radically different outcomes in the product market.
This observation leads to a fascinating thought experiment. Imagine there were a magic switch allowing us to control whether all public firms in the United States maximized individual profits or shareholder value. What would happen if we toggled the switch from “profits” to “shareholder value,” and vice versa? How would the pricing and production decisions of firms change? And what would be the resulting effect on consumer welfare?
The result of this thought experiment has real-world policy implications. Recent research shows that there has been a dramatic increase in the extent of common ownership among U.S. publicly traded firms. BlackRock and Vanguard, for example, are now among the top five shareholders of almost 70 percent of the largest 2,000 publicly traded firms in the United States today, compared to 20 years ago, when that number was close to 0 percent for both firms. What are the product market and distributional implications of this phenomenon? Unfortunately, magic switches such as the one described above do not exist in real life—but that is why economists use models.
In our new working paper, “A Tale of Two Networks: Common Ownership and Product Market Rivalry,” we build a novel macroeconomic model in which firms compete oligopolistically to maximize shareholder value or profits. Our model leverages two extremely large datasets that provide us with a “map” of the competitive landscape for U.S. public corporations.
The first of these two datasets is available due to the seminal work of economist Gerald Hoberg at the University of Southern California and business administration professor Gordon Phillips at the Tuck School of Business at Dartmouth College, which provides a metric of the extent to which any two publicly traded firms produce competing products. It thus represents the network of product market rivalries among public corporations. The latter dataset comes from digitized U.S. Securities and Exchange Commission forms 13(f) and provides information about how many shares large asset managers own in each publicly traded firm.
Our model allows us to toggle that magic switch and simulate the “deadweight losses” due to the anticompetitive effects of common ownership. A deadweight loss in economics is the loss to society (in dollars) generated by some market inefficiency, which results from firms charging higher prices than they would in a competitive market.
The important caveat here is that our model cannot detect what objective—profits, shareholder value, or even something entirely different—that firms actually maximize. (Multiple working papers, however, already exist that analyze the evidence of common ownership effects in specific industries, among them the airlines and the ready-to-eat cereal industries.) Our objective is to neither replicate nor dispute any of these industry-level findings. Instead, our study addresses a new research question and tries to provide a dollar estimate of the economywide impact of common ownership.
We find that in 2018, common ownership among big investment management companies raised producers’ profits by an estimated $378 billion, lowered the consumer surplus by $799 billion, and generated a deadweight loss amounting to 4 percent of total surplus produced by U.S. public corporations in 2018, compared to 0.3 percent in 1994.
It is also easy to see how common ownership is likely to have significant distributional effects that primarily hurt the less wealthy. The top 10 percent of wealth-holders in the United States owns an estimated 89 percent of all stocks and mutual funds, with the wealthiest 1 percent owning 54 percent of those assets. At the same time, 42 percent of all Americans owns no stocks—individual stocks or stocks included in a mutual fund or retirement savings account, such as an 401(k) or IRA—at all.
The more affluent are at least somewhat hedged from the anticompetitive common ownership effects because they make up for the loss in consumer surplus through larger capital income returned to them as shareholders. For the least wealthy, the loss in consumer welfare is more likely to go unmitigated.
Like every model, ours requires assumptions. An important one is how each firm weighs the interests of different shareholders. Does the firm weigh institutional investors in proportion to the shares they own in the company, or does it give, for example, a greater-than-proportional weight to its largest shareholders or block-holders? We study how sensitive our estimates are to these varying corporate governance assumptions. While the specific numbers can vary, what does not change is the qualitative finding that common ownership has the potential to cause significant inefficiencies and consumer harm. This finding also is robust to different assumptions about fixed costs of firms and their intangible capital assets.
There is an active debate among economists, legal scholars, financial analysts, and antitrust and financial regulators alike about the specific mechanisms through which common ownership lessens competition. Some possibilities are that uncompetitive practices might be encouraged directly through active corporate oversight or indirectly via compensation schemes that do not sufficiently encourage top managers to compete. These remain highly relevant possibilities but are also controversial, given the large competitive and distributional effects of common ownership.
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Our findings, combined with investments continuing to pour into large, diversified funds, suggest that antitrust policy and financial regulation may have to address this new challenge. Academic research is only beginning to scratch the surface when it comes to the welfare effects of common ownership. Various other consequences of common ownership on firm decision-making, including labor market power, innovation, firm productivity, and cost efficiency, and dynamic collusion incentives are still waiting to be investigated.
In light of the meteoric rise of common ownership and its relevance for antitrust policy and financial regulation, our paper presents several reasons for lawmakers and regulators to pay attention to this issue.
— Florian Ederer is an associate professor of economics at the Yale School of Management. Bruno Pellegrino is an assistant professor of finance at the University of Maryland’s Robert H. Smith School of Business.