The Common Ownership Trap: Less Competition Does Not Always Mean More Value

In recent years, the increasing presence of large institutional investors, who hold equity stakes in competing companies, has sparked discussions about the possible negative effect on competition. This situation, referred to as “common ownership”, does not simply represent a financial diversification strategy, but can have direct implications for the competitiveness and governance of firms.

In a study (“Common Ownership, Competition, and Corporate Governance“) published in Management Science, Fausto Panunzi (Department of Economics/IGIER, Bocconi University) and Vincenzo Denicolò (University of Bologna) propose a theoretical model that analyzes this phenomenon in depth, offering a comprehensive picture of the motivations and consequences of common ownership.

Why common ownership reduces competition

According to traditional economic theory, institutional investors would tend to behave passively, merely diversifying risk. However, common ownership can also create strategic incentives: when an investor holds significant stakes in multiple competing firms, it can indirectly influence management to reduce the intensity of competition among these firms. Such reduced competition leads to higher prices and, consequently, higher profits, thereby increasing the value of the companies involved.

As the authors point out, managers’ behavior tends to follow the so-called “proportional control” model: indeed, managers of firms tend to consider the interests of shareholders in proportion to the company stock held by each of them. When a common investor has significant stakes in several firms active in the same markets, managers thus may, even unintentionally, limit competition in order to favor overall higher profits for common shareholders.

The trade-off with corporate governance

Despite the apparent economic benefit, common ownership also entails costs. In particular, corporate governance can deteriorate significantly. In fact, when an institutional investor buys shares from large shareholders (“blockholders”), the latter reduce their direct interest in the company and, as a result, are induced to decrease their efforts to monitor and supervise managers. 

“Common ownership reduces the intensity of competition, which is beneficial to profits, but simultaneously reduces the incentives of block shareholders to take initiatives that increase the value of the enterprise, which is detrimental to profits.”

This reduced oversight allows managers greater freedom to appropriate private benefits, at the expense of overall shareholder value.

The challenge, then, lies in balancing the benefits of reduced competition (higher profits) with the costs associated with less effective governance.

Determinants of common ownership

The proposed model identifies two key variables that determine the optimal level of common ownership:

• Intensity of competition: the more competitive the market, the greater the benefit institutional investors can obtain from common ownership. Therefore, higher levels of common ownership are expected in highly competitive and fragmented markets.
• Quality of corporate governance: when monitoring managers is less necessary (e.g., because of stricter regulations), institutional investors have an incentive to increase their stakes in competing firms. Paradoxically, this can lead to worse conditions for consumers, with higher prices due to reduced competition.

Policy and empirical implications

“Large institutional investors should give more weight to sectors where market concentration is lower and the intensity of competition is higher, thus providing more room for common ownership to increase the value of enterprises.”

Panunzi and Denicolò then suggest that, despite the financial benefit to shareholders, common ownership can generate significant social costs in terms of reduced competition. According to the authors, antitrust authorities should take these effects into account by carefully evaluating transactions that significantly increase common ownership in particularly competitive industries.

Vincenzo Denicolò, Fausto Panunzi, “Common Ownership, Competition, and Corporate Governance”, Management Science Vol. 71, No. 5, DOI https://doi.org/10.1287/mnsc.2023.03467