Journal Name: University of Pennsylvania Journal of Business and Employment Law

Volume Number: 25

Issue Number: 1

Abstract:

A phenomenon known as “Common Ownership” arises when shareholders hold substantial stakes in competing firms. Although recent empirical evidence has illustrated how common concentrated owners are associated with higher product market prices and lower output, scholars remain divided as to the precise mechanism through which common ownership can induce anti-competitive outcomes. In this Article, I propose a novel framework to evaluate the likelihood of candidate mechanisms of anti-competitive harm in common ownership. I argue that all disagreements over the anti-competitive mechanisms of common ownership hinge on a central determinant: the transaction costs of internalizing pecuniary externalities between portfolio firms. I define two broad categories of transaction costs: information costs and coordination costs. Information costs relate to costs involved in implementing mechanisms of anti-competitive harm that rely on unilateral effects, while coordination costs relate to costs involved in implementing mechanisms that rely on coordinated effects. Where the transaction costs of internalizing such externalities are positive, common owners will tradeoff the gains from internalizing these externalities with the costs involved in doing so. I characterize this tradeoff by introducing a new parameter: “tailoring.” The degree of tailoring reflects the extent to which a common owner would rationally exert actual control. Highly tailored mechanisms internalize more pecuniary externalities, but incur more transaction costs. On the other hand, untailored mechanisms internalize fewer pecuniary externalities, but incur less transaction costs.

In the context of institutional investing, my analytical framework suggests that institutional investors who are also common owners face large transaction costs in implementing highly tailored mechanisms. These investors are far more likely to pursue relatively untailored mechanisms’ effects instead. Similarly, institutional investors face relatively large transaction costs in implementing mechanisms that induce unilateral effects and are thus likely to prefer mechanisms that induce coordinated effects. I contend that optimal policy responses to the anti-competitive effects of common ownership should focus on mechanisms that institutional investors are likely to harness in reducing competition between their portfolio firms. Here, legal reforms can play a critical role in changing the incentives of common owners by increasing the transaction costs of implementing particular mechanisms of anti-competitive harm and in changing the incentives of non-common owners by decreasing the transaction costs of implementing pro-competitive mechanisms. These mechanism-specific remedies have significant advantages when compared to competing proposals in the literature.