The rise of indexing mutual funds and other diversified investors is increasing the temptation for public companies to act in the interests of their rivals, a trio of professors say.
Their study, “Common Ownership in America: 1980-2017,” is the latest entry in a growing body of research looking into whether the expanding influence of giant shareholders like passively managed funds is making American companies less willing to compete. When so many businesses have the same owners, the theory goes, rivalries between them weaken, as firms face growing incentives to keep people other than their customers and employees happy.
The paper shows implied incentives linked to common ownership have risen to “economically significant” levels. But large indexers like BlackRock Inc., Vanguard Group Inc. and State Street Corp. have an “ambiguous relationship” to this trend, which effectively predates their march to preeminence.
To test the thesis, the researchers examined something called “profit weight” -- how much value a company theoretically places on its peers’ earnings in light of common ownership. They found it surged from 0.2 in 1980 to 0.5 by 1999 to almost 0.7 in 2017, according to models they developed. Zero would suggest firms do nothing but maximize their own profit, while 1 means “full collusion” or “the weight a merged firm places on an acquired subsidiary,” according to the paper.
Reward Systems
To be sure, the paper doesn’t prove anti-competitive practices are going on -- just that the reward systems for them exist.
“This paper is descriptive and shows the change in incentives over time due to indexing and institutional ownership,” Michael Sinkinson, co-author and assistant professor of economics at the Yale School of Management, wrote in an email.
Anti-competitive behavior involves eschewing practices that drive up costs industrywide (such as poaching rivals’ workers), or that may reduce expected revenue (like a race-to-the bottom in prices). Broadly speaking, to the extent that this behavior prevails, it’s positive for capitalists and negative for consumers.
To get to a profit-weight estimate, the researchers looked at every pair of companies in the S&P 500 Index and tried to calculate how much investors in one benefited from earnings at the other.
“If I have a profit weight of 0.5 on my competitor, that means a dollar of profit to him is equivalent to $0.50 of profit for me,” Sinkinson said. “This is why we say these profit weights could soften competition: If I have positive profit weights on my competitors, then I am less likely to compete more aggressively since hurting my rivals also hurts me.”
Indexing Trend
An examination of 13F forms on investor positioning shows that the share of the S&P 500 owned by fund managers with more than $100 million in assets has risen from less than 40 percent to above 80 percent by 2017, according to the paper. The breadth of common shareholders appears to be a more significant contributor to this dynamic than a high degree of concentration among a few shareholders.