Loading summary
Transcript48 lines
- [00:01]
Kurt Nickish
You're listening to Is Business Broken, A podcast from the Merotra Institute for Business Markets and Society at Boston University Questrom School of Business. I'm Kurt Nickish. When the same big investors buy stakes in multiple competing companies, are those firms still competitors? When they practically have the same owner, do they set their prices differently? Do they lose their drive to innovate? This is not a thought experiment. It's real and widespread, a phenomenon known as common ownership. The growth of big institutional investors is quietly reshaping industries in ways most of us never notice. And researchers are only beginning to understand. They're asking, is common ownership just smart investing or is it reducing competition and driving up costs? And what, if anything, should be done about it? Here to make sense of it all is Florian Ederer, Alan and Kelly Questrom, professor in Markets, Public Policy and Law at BU Questrom.
- [01:09]
Florian Ederer
Florian, thanks so much for joining us.
- [01:12]
Thank you for having me.
- [01:14]
So can you help define what common ownership is? What exactly are we talking about here?
- [01:20]
Common ownership refers to a situation where large investors hold minority interests in several companies competing in the same industry. So common ownership is really because these are common owners. So these are owners that hold several of these companies in the same industry. And it's a term that sometimes is also used in completely different setting, sometimes when it refers to common ownership of assets for the overall greater common goods, when the entire set of people in an economy hold assets. But that's really not what common ownership in this particular context refers to here. It's really large investors, asset management companies most of the time that hold these minority stakes in competitors in the same industries.
- [02:14]
Gotcha. And so that's the meaning of common there, not the fact that it is common or rare. But on that note, it has become more, more common. Right. This isn't a totally new phenomenon, but it's a trend. Yeah. Explain that history.
- [02:29]
It's actually an old idea to some extent. This theory of common ownership started as early as the 1980s. So people had these concerns when they formulated the so called common ownership hypothesis that when these companies that usually would be competing against each other are held by these common investors, then maybe they have less of an incentive to compete against each other. And so people theorized about this idea starting in the early 1980s. But back then, common ownership wasn't all that common. It was not as widespread as it is now, almost 40 years later.
- [03:13]
So what happened?
- [03:14]
Well, what happened is that we in business schools were very, very, very successful at convincing people to invest in a diversified way. I think one of the key things that you first learn when you go to business school or if you take any course on investments is that the professor will tell you that it's not a great idea to put all of your savings into single stocks, but rather what you should be doing is you should be diversifying your investments. And so you shouldn't just put it in one company, but you should put it in several companies. Now when you do that, that means that you get a rise of diversified investments, sometimes also even referred to as a democratization of investing. Because lots and lots of people have access to investing in a diversified way. And we've also made that much, much more accessible, made it much more or less costly. You can invest in index funds, you can invest in mutual funds, and when you do that, you tend to do that through these large asset management intermediaries. And with this rise in diversified investing that has opened up not just for a small class of people or small share of the popular of the working population, but really has opened it up to everybody. That then means that if everybody invests in a diversified way and invest through large asset management companies, then those large asset management companies will end up holding large shares of several firms that usually would be competing against each other.
- [04:58]
Yeah. So let's talk about who these common owners are and just how much of the economy or how much of these the market, so to speak, how much of these companies in an industry they they actually own.
- [05:13]
These companies tend to be ones that you and I perhaps use for investing. So the they're sometimes referred to the most famous ones or the largest ones among them, the so called Big Three, that's BlackRock, Vanguard and State Street. But there are others, including Fidelity Vanguard.
- [05:33]
Of course being the company that, that pioneered index fund investing.
- [05:38]
Exactly, exactly. Jack Bogle and Vanguard really made it very accessible to invest in a diversified way for a large swath of the population. So these tend to be also then the companies that then end up holding this large set of shares potentially sometimes in competitors. It's not necessarily a conscious decision that they make to directly invest in several of these firms that are potentially competing against each other, but it's really driven mostly by retail investors that end up investing in these companies through these intermediaries. Another reason why this common ownership has risen is because pension investments tend to be in equities, tend to be in the stock market and of course are also investing in a diversified ray of. Rather than just putting all of the eggs in one basket or in one company. Now how much has this grown? It used to be really a completely rare phenomenon. So there's this very rare cases in the 1980s where these large investors had significant stakes in several companies in the same industry. But if you look at the overall Trend Nowadays, over 80% of all companies that are publicly listed in the United States tend to have an owner that's one of the big three. So it tend to be. So the largest owner of all of 80% of publicly listed companies tends to be either BlackRock, Vanguard, or State Street.
- [07:19]
Yeah. Well, we talked in our series on executive compensation about institutional investors and how they often even act with a common voice. They influence executive compensation packages, they influence how companies are run and their governance, and they often vote the same way. So I imagine if you have a number of these institutional investors all owning stocks in the same companies, that they almost add up to a big block.
- [07:49]
Absolutely, yeah. Not only are they large individually, but they're also even larger as a block. Now, not all of them have the same influence. Some of them act in a more passive way. Some of them act in a more active way.
- [08:07]
By passive and active, you mean just holding stocks versus trying to encourage management to make certain moves or to innovate or to, you know, how they run their companies.
- [08:20]
Is that exactly?
- [08:21]
Okay?
- [08:21]
Yeah, there's definitely already a difference in how active the engagement is with management. If you just look at the big three, Vanguard tends to be much more passive than blackrock. But the big three aren't the only large common owners. There are many, many others. There was a time when Berkshire Hathaway, you know, the Warren Buffett holding company, was also invested in several airlines. And of course, the way that Berkshire Hathaway interacts with management is very, very different from the big three because they very much take an active engagement role with the management. And so this can differ. So sometimes they act as a block, sometimes they do not act at all and are quite passive. And sometimes they take extremely active choices vis a vis the management of these various companies that they invest in.
- [09:18]
You mentioned how as early as the 1980s, there were theories about common ownership and what kind of effect it's had, but the fact that it's grown so much with the rise of mutual funds and index fund investing and pension funds owning so much of the public market economy. Now, there's been more research. In your studies, you've uncovered a number of interesting effects in companies and industries that have common owners. How it can affect competition, prices of products in the market, innovation, executive compensation, managerial incentives. What have you seen that happens when this power is consolidated? Like this?
- [10:00]
Yeah, I think it's a fascinating question. Of course, I think it's a fascinating question because much of my work in the last couple of years has been in this space. But just to clearly state the hypothesis of common ownership. Again, it's a situation really, where you have these common owners that hold large stakes in companies that are competing against each other. But now, because the companies are held by these common investors and common owners, perhaps they have less of an incentive to engage in such intense competition with each other. Now, that has positive effects for the profits, and that's something that the investors actually quite like, and that benefits potentially all of us who are invested in these companies, but that has potentially negative effects for consumers of the products that these companies make.
- [10:58]
So just as an example here, if you represent a lot of shareholders in Coca Cola and Pepsi Cola, then you basically aren't going to pressure one of them to lower their prices and really go after the market share of the other, because you get more profits in one company, you get less in the other, and it's all kind of a wash. You would rather see both companies keep their prices higher and make more money across the market because you own that market.
- [11:31]
Exactly. It's a very, very simple logic. And when I talk to people about common ownership that are not in economics, they immediately say, yeah, but isn't that totally obvious that this is something that would happen? And I said, well, it's something that is obvious once I've explained it to you. And this wasn't a situation that was so predominant 40 years ago, but it is very much a dominant paradigm right now. And it's not just Coca Cola and Pepsi, but it's actually widespread through many, many of these industries. The reason why this literature in academia really got going was not because we formulated that theoretical hypothesis 40 years ago, but rather because a team of authors of Martin Schmaltz, Jose Azar and Isabel Tekou were successful in showing empirical evidence of exactly this effect. And they showed this in the airline industry, where, to just put it simply, where they showed that on airline routes where you have more common ownership, so where the airlines that are competing with each other share many of the same owners, on those routes, ticket prices tend to be higher than on airline routes that are comparable but have less common ownership. And so that's an empirical piece of evidence in favor of this common ownership hypothesis, because these higher prices are coming from lessened competition because of increased common ownership. And that paper, you know, was eventually published in 2018 in one of the leading journals in Finance and economics. And it has been tremendously influential because it sparked all kinds of additional questions, which is, you know, if this is happening in airlines, is it also happening elsewhere, happening in other industries? It also sparks the question of, you know, if this is happening in all these industries, how does it actually work? Do these investors directly intervene with management? Do they tell them what prices to set? Do they tell them which airline routes to compete aggressively on or not? Or what products to really go after market share? And which products maybe to engage in not so intense competition with these other firms in the industry?
- [13:59]
Yeah, understanding the mechanisms of how this work is what researchers like you have been focused on. You mentioned Berkshire Hathaway and Warren Buffett, who famously had been burned by investing in airlines in the past and said he would never invest in airlines again. And then around this time, Berkshire Hathaway was investing in multiple airlines again. The industry was profitable again and not just investing in one and trying to pick a winner, but just, you know, investing in more airlines across the board. So it's clearly investors have responded to this too, and see value in owning companies that are commonly owned.
- [14:42]
Yeah, absolutely. I mean, the prediction is that companies that are commonly owned are not going to compete quite so aggressively with each other and lessen competition will lead to higher prices and ultimately higher profits. But there's still then this question, which might be of interest to just academics, but I think it's also of interest beyond academia. And in fact, regulators have raised this question, if this is really happening, what is the mechanism through which this is happening? What is leading to this lesson? Competition. And that's some of the work that I've done on this. And what we try to show is that in those companies that tend to have more common ownership, so these types of companies then tend to have lessened incentives for the CEOs to compete aggressively against competitors in their own industry. Now, how does that work? It works often through lower pay for performance and lower wealth, performance sensitivity. So the CEOs aren't quite so strongly rewarded for good performance of their individual stock, but rather they're rewarded through good performance of the overall industry. They're not benchmarked quite as much against the performance of other firms in the industry. And that perhaps gives them lesser incentives to make the firms run as efficiently as possible, but also leads the firms not to engage in such intense competition and less likely to start. Start price wars. They're less likely to really aggressively expand production. They're less likely to aggressively enter other markets in that industry. And the result of that Then is higher profits, but sometimes also leads to inefficiencies in that the firms are not quite as productively run as they could be if the CEOs or top management were really heavily incentivized just on good individual firm performance.
- [16:48]
Is this a hard field to study? I mean, you've given examples of empirical research. You're also talking about sweeping portions of the market, or you're studying industries, companies across an industry and trying to make connections to executive compensation at those companies. I'm just curious how tricky it is from a researcher's point of view to really be able to connect the dots.
- [17:17]
I think it's an exciting field to work in, but it's also challenging. One thing that I will say, which is different from the research that I usually do. So most of my research focuses on antitrust and competition issues and it also looks at innovation effects. But working on common ownership has been uniquely challenging in that there is a huge amount of pushback also from the asset management industry. And that's different from, you know, submitting your paper and discussing it at conferences and having it discussed by referees, which is, you know, something that is perhaps less interesting for people outside of academia. But here you have a real direct contact with a trillion dollar industry and you're saying that trillion dollar industry is leading to anti competitive outcomes. And so it's natural, I think, for that industry to feel challenged by this research and to cast doubt sometimes also on that research.
- [18:21]
Sure. So we're talking about airlines here, but of course this can happen in any industry. Researchers have found that in banks, for instance, in just by looking at banks that are commonly owned versus banks that are not commonly owned in certain parts of the country, you can see that the fees at banks that are commonly owned are higher that the fees charged on just having an account or overdraft fees, things like that, Those tend to be higher at commonly owned banks rather than banks that are not commonly owned. What other real world industries has common ownership been shown to have a significant impact on? Pricing?
- [19:05]
So airlines is one of those, banks is one of those. Another one is ready to eat breakfast cereal. Where also people have looked at common ownership. There they found relatively small effects of common ownership, so not as much anti competitive effects there. There are studies that look at consumer packaged goods and they do find increased prices in those industries due to common ownership. And then I think one of the ones that I particularly like is some work done by one of my former students looks at entry in pharmaceuticals and shows that generic pharmaceutical producers are less likely to enter into pharmaceutical markets if there's significant common ownership between the entrant and the incumbent. And that again, makes sense because, you know, why would you want to enter and destroy the profits of the incumbent pharmaceutical producer if your investors are the same investors as those of the incumbent?
- [20:09]
What about the effect on innovation? What have you and researchers in your field found about that?
- [20:16]
Yeah, so companies, of course, do much, much more than just decide, you know, which airline routes to fly and how much to charge, how much to price tickets for. But they do whole set of things. And one of the things that we particularly care about is how much innovation they do, because innovation really is the longtime driver of growth. If innovation takes the form of business stealing, so if I innovate, I take away market share from you, then maybe common ownership is going to reduce innovation because the common owners actually don't want this form of market business stealing to occur, just like they don't want price wars to occur. But there's another aspect to it, which is that when I as a company do innovation, then sometimes that has positive spillovers on other companies that maybe are innovating in the same space. These spillovers I cannot maybe directly capture, but they still are beneficial for other firms in the industry. And if I do that, then maybe I'm not fully internalizing. So I'm sorry, I'm using here economic speak, but internalizing and basically not taking into account that when I do innovation, it has positive effects for other companies. And so in that context, common ownership would actually have a beneficial effect on innovation.
- [21:40]
So this would be something like a pharmaceutical company that innovates a new therapy. They have a patent on it, they lose the patent, but the common owners are happy because whoever starts making generic drugs after that, they're. They're making money from that innovation after the patent expires anyway.
- [21:58]
Exactly. Or I'm developing a new chip and that I can capture some of that through increased sales. But actually, the patents that I have on that chip can be used by others. Or I discover a new way of making these chips that gets transmitted to other firms out there. These benefits I cannot capture. But perhaps the investors at my company also invested at these other companies and they can capture them. So that would then actually stimulate innovation. And we've seen examples of this, you know, where. Where BlackRock in particular was very, very vocal during the COVID 19 pandemic of saying we should be sharing a lot of this information. And maybe. And they shouldn't just be with one single firm, but rather it would be great if These would be dissipating to several of these firms.
- [22:49]
I mean, it sounds like for some effects, it's a bit of a mixed bag. Like with innovation, you certainly see some benefits to shareholders and investors, but you also see higher prices and less competition across an industry. And now many industries, because so many are commonly owned. What is the danger here to less competition? Like who's going to pay for that?
- [23:19]
Yeah, as always in economics, it's a trade off. Common ownership is good for profitability of companies, it's good for the profits of investors, but it's not great for consumers. Some of the work that I've done with my co author Bruno Pellegrino at Colombia tries to quantify that and tries to really estimate what is the deadweight loss of common ownership. So if I have gains on the one hand for the investors, but I have losses on the other hand for consumers, who overall gains. And on balance, is this a good effect? And what we find is that on balance this is a negative effect because the losses to consumers are larger than the profit increases for the investors. So it's literally just putting the losses in consumer surplus and the gains in profits together we show that in sum, that used to be sort of a negative effect of about 1.3% of GDP in the early 1990s, but by the early 2000s, so by 2021, that effect is actually quite large in that this deadweight loss is as large as 13% of total surplus.
- [24:38]
Yeah. Well, it's interesting because this made me think back to the Gilded Age when you had industrial titans and JP Morgan famously bought up competing railroads. Right. He managed to get stakes in competing railroads and got them to cooperate and keep prices high and not to compete. That was a trend that was had a lot of negative effects downstream and hurt a lot of people and led to a lot of social unrest and huge changes, including antitrust law. There is a history with this. How pervasive of a problem is this today? And what would the consequences be if nothing's done?
- [25:24]
Yeah, I think it's a really interesting and challenging question. First of all, I should say that I love Ron Chernoff's biography of JP Morgan and the whole house of Morgan. And my favorite part is exactly this description of JP Morgan buying up parts of several railroads. But that is under current law, of course, a clear antitrust violation because. Because it is controlling stakes in several direct competitors. Whereas what we describe here under common ownership is not quite so direct and controlling, but tends to involve partial minority interests.
- [26:03]
But collectively, they may not even be controlling, but practically they seem controlling.
- [26:09]
It has perhaps smaller effects, but the direction of the effect is similar. And I think, you know, there was already a. Just like we had changes in antitrust law at the beginning of the 20th century, we had changes in how we handle competition policy in nowadays in the 21st century. The most recent merger guidelines from 2023 have 11 guidelines. And I'm very happy that the 11th guideline is specifically about common ownership, about these partial minority interests, and just highlights that this can have negative anti competitive effects that hurt consumers. And given that antitrust policy is about protecting consumer surplus and preventing harm to consumers from lack of competition, it's great to see that policy has taken this up quite quickly. And it didn't take several decades for this to percolate into law. Doing anything beyond sort of this awareness and saying that we should consider this when we look at competition policy and antitrust. It's very difficult to really strike a balance here between investor interests and consumer interests. There's also another aspect of this which we haven't really covered for common ownership, which is that if common ownership gives you increased product market power, so maybe the ability to raise prices and to cut back on production, or maybe not to compete so aggressively on innovation, maybe it also provides you with labor market power, maybe it allows you to not raise wages by quite as much if you were aggressively competing for talent. And so there's a whole set of research now coming out looking also at potential labor market effects of common ownership. And it's finding some mixed evidence, but tends to be evidence in the direction of common ownership maybe not being all that great for workers either.
- [28:19]
I mean, overall, it sounds like common ownership would only be more likely to contribute to income inequality than reduce it.
- [28:26]
Absolutely. Because it's. When we, When I told you previously about this trade off between increased profits and consumer surplus, I really wasn't making a distinction between the identity of who's on either side, but the people that tend to profit the most from increased investor profits tend to be wealthier individuals. And people that tend to be more hurt or relatively more hurt by higher prices, lower quantity, less innovation, reduced wages tend to be people that are not quite as wealthy. And so that would then also mean that higher common ownership leads to increased income and wealth inequality.
- [29:09]
Yeah, and you mentioned democratization of stock ownership earlier. You know, and some people can think to themselves, well, you know, but if you own stocks and you have 401K or a 403B, if you buy mutual funds, you're getting the benefit of this but half of Americans don't own stocks.
- [29:32]
That's right. I think it's a very, very good marketing ploy. I don't want to say everybody benefits, but these benefits also tend to be extremely concentrated towards the top end of the income and wealth distribution.
- [29:51]
It's a little bit like forgiving college debt. And it's really only you're really helping. If that's a populist move, you're really just helping one certain portion of the population. Yeah. So based on your research and your track record of following this field, where do you see this issue heading in the next decade? And we're in an anti regulatory environment now. Do you see potential for markets to self correct. Do you see a growing realization that regulators have that they need to step in more? What direction is this going do you think?
- [30:30]
So I think that there has been some activity on the market side in terms of self regulation. I think the asset management companies are now much more tuned to this problem. I think one of my favorite factoids on this is that none of the large asset management companies had antitrust councils before the rise of this research and now they all have antitrust legal counsels on this. And so I think there's certain more awareness and there's clearer guidelines also on how to engage with management and what is legal and what is not legal. So I think that there's already an improvement. There's also been this rise of so called pass through voting large asset management companies really saying okay, we are not directly engaging with management, we are not directly voting on these management proposals but rather we are having our retail investors vote on this. And I'm not sure how effective that is really going to be because I know what I do when I receive these communications and they go straight into my a recycling bin basically. And I don't do anything because I just passively hold all of these stocks. So I think on the market side I don't see much potential for self correction. I think there's absolutely going to be more policy response. Policy response tends to be slow here in this case given that it was already in the merger guidelines in 2023 when you know, this research on the empirical side really only started up maybe in 2016, 2015. I think that actually was relatively swift. There have been some proposals also in Congress already on this about potentially changing even the laws around this of what is allowed and not allowed in terms of holdings of competitors. That hasn't gone very far and I'm not sure what the next four years are. Going to bring, but I don't expect there to be too much development either. I think one interesting development that is again more on the on the private side is that there are now antitrust lawsuits also based on common ownership. There's one lawsuit led by the Texas Attorney General Ken Paxton and several other states that have sued several of these large investors like BlackRock for common ownership and anti competitive effects of common ownership, particularly as they relate to divestment from coal in power plants. And I think it's going to be particularly interesting to me where this is going to lead.
- [33:26]
Florian, this has been super interesting. Thanks so much for talking about this.
- [33:30]
Thank you so much for having me.
- [33:33]
Kurt Nickish
That's Florian Etterer, Alan and Kelly Questrom, professor and Markets Professor, Public Policy and Law we'll be coming out with some new episodes soon. In the meantime, please follow the show on Apple Podcasts, Spotify or wherever you listen. Thanks for listening to Is Business Broken? I'm Kurt Nickish.