This presentation by Martin Schmalz from the University of Michigan was made during the discussion “Common ownership by institutional investors and its impact on competition” held at the 128th meeting of the OECD Competition Committee on 6 December 2017. More papers and presentations on the topic can be found out at oe.cd/21u.

1. Common Ownership and Competition:
Facts, Misconceptions &
What to Do About It
Martin Schmalz
University of Michigan

2. Key: Competition requires incentives to compete
1. Firms (only) do what somebody gives them incentives for.
2. Competition requires that firms have incentives to compete.
3. Separate ownership gives such incentives.
Common ownership reduces these incentives.
Most else is a distraction from these facts.

3. Separate ownership  incentives to compete
Virgin America
(2016Q2)
%
Richard
Branson
30.99
Cyrus Capital 23.69
Vanguard 2.91
BlackRock 2.27
Alpine
Associates
2.12
Hutchin Hill
Capital
2.1
• Branson, Cyrus, … can benefit
when Virgin America
– reduces costs & prices
– improves quality
– increases capacity
– gains market share
• relative to Delta Air Lines,
United Continental,
American Airlines
• Branson: use IPO proceeds for
capacity increases, new routes

4. More common ownership structures
• Top 7 investors control 42% of votes. Each one also owns Delta, SWA, …
– United has one institutional investor in top-100 that is not an owner of DAL, SWA, AA.
Delta Air Lines % Southwest Airlines %
Berkshire Hathaway 7.25 Berkshire Hathaway 15.03
Vanguard 6.13 PRIMECAP 11.87
BlackRock 5.84 Vanguard 6.28
Landsdowne 3.90 Fidelity 5.41
PRIMECAP 3.75 BlackRock 5.04
State Street gA 3.68 State Street gA 3.69
United Continental % American Airlines %
Berkshire Hathaway 9.11 T. Rowe Price 12.89
Vanguard 7.33 PRIMECAP 10.46
PRIMECAP 7.19 Berkshire Hathaway 9.54
BlackRock 6.72 Vanguard 6.15
PAR Capital 5.26 BlackRock 5.20
T. Rowe Price 3.37 Fidelity 3.71
State Street gA 3.33 State Street gA 3.58

5. So which investor is supposed to give United
incentives to compete against Delta, Southwest, …?
• Common owners do not benefit like separate owners when
United increases capacity & reduces prices
• Market share is zero sum
– One side of the portfolio wins, the other loses
– Attempt at stealing market share reduces prices and profits
• Intervention to increase competition particularly absurd
– Increases governance costs
– Reduces portfolio profits and asset value

6. Look for: error of omission, not commission
• Common owners have fewer incentives to encourage
their portfolio firms to compete away market share
from each other.
– But undiversified owners (`Branson’) do.
• “We have no incentive to intervene in competitive
strategy” is a problem description, not a defense.
– `Branson’ has incentives to intervene, pro-competitively.

7. Fact: forceful removal of a United passenger in April ’17
decreased United’s stock price –
but increased portfolio value of United’s largest owners
Why? Competitors’ stocks gained.

8. Academic research: theory
• Know since Rotemberg (1984) that common ownership can
cause monopoly outcomes
– “funds that concentrate on specific industries do the most harm”
• Moreover: all firms and investors can benefit from less
competition in equilibrium
– Reduced competition consistent with fiduciary duty

9. Empirical studies
1. Common ownership causes higher airline ticket prices
Azar, Schmalz & Tecu, Journal of Finance
2. Similar results for U.S. retail deposit banking
Azar, Raina, & Schmalz, WP 2016
3. Economy-wide reduced investment despite record profits
due to corporate ownership by “quasi-indexers”
Gutierrez & Philippon, NBER 2017
4. Weaker incentives to maximize own profits in industries with
more common ownership
Antón et al., WP 2017
5. …

10. Azar, Schmalz & Tecu:
`Treatment’ with a `pill’ of common ownership
- Variation in common ownership due to BlackRock’s BGI acquisition
- Market shares mechanically fixed

11. Ticket prices in `treatment’ routes increased relative
to `control’ routes after acquisition

12. Claim: Index funds are too small to matter, and their
managers have no incentives to ask firms to collude.
Facts
1. Distraction from the key fact: index fund managers don’t have
sufficient incentives to push firms to compete
2. Collusion unnecessary when firms lack incentives to compete
3. Misleading focus on index funds instead of common
ownership
• Funds are quite small (<$250bn vs. $25 trn US market cap)
• Fund families can be very big (e.g. BlackRock: $6 trn)
• Centralize voting of shares; look like `quasi-indexer’ at the family level
• Berkshire Hathaway, hedge funds, sector funds (e.g. JETS) are not index
funds, but drive much common ownership

13. Claim: Asset managers don’t benefit from reduced
competition
• Fact
1. Mutual funds charge a % of the value of assets
2. Asset values increase when competition decreases
Both ultimate investors and asset managers benefit from
reduced competition.

14. Claim: “Common owners also own suppliers and
customers”
• True, but:
– Berkshire Hathaway is top shareholder of 3 of 4 largest U.S. airlines
– also of Coca Cola (a customer)
• Does Delta Air Lines charge lower prices to all clients because
one of their clients is Coca Cola?
Vertical common ownership exists, but does not contradict
anti-competitive effects of horizontal common ownership.

15. Claim: “Managers are paid in stock”
• Partially true, but:
– Stock prices increase when the industry is doing well
– Stock compensation aligns managers’ incentives with industry profits, and thus
with common owners
• To incentivize managers to maximize own profits and not industry profits,
have to index 100% of wealth to rival performance (Holmström)
– Prediction fails in the data (Gibbons & Murphy 1990)
• Common owners have reduced incentives to index pay
– Gordon 1990; Hansen and Lott 1996; Rubin 2006
• Empirically,
– More common ownership leads to less indexing (Liang 2016)
– managers’ wealth less sensitive to performance in more-commonly-owned
industries (Anton et al., 2017)

16. Claim: “Maximizing own firm’s value is the only
strategy all shareholders can agree on.”
• True only if all firms are price takers (Hart, 1979)
– Fails when firms strategically interact and e.g. when
shareholders hold competitors
• Unanimous agreement on monopolistic behavior
predicted by Rotemberg (1984)

17. Critique by Kennedy et al.
• Kennedy et al. replicate AST’s main results, but disagree
with the interpretation on theoretical grounds
– Develop their own, new theoretical model
– Estimate it on a selected 10% subsample of the data
– Using nonstandard methods requiring stronger assumptions
– Find negative effect of route length on marginal cost and
no significantly positive effect of common ownership
• See Azar, Schmalz, and Tecu (SSRN working paper, 2017) for
more details

18. Other papers claiming no significant effects
• Based on known-to-be-erroneous ownership data
– In addition, omit aggregating owners to the level at which
shares are voted
– In addition, exclude individual owners (such as Branson)
• Using noisy data generally leads to attenuated results
– Main finding: anti-competitive effects driven by
largest markets

19. … as previously shown by Azar, Schmalz & Tecu

20. Claim: Addressing the common ownership problem destroys
popular index funds that democratize investment
• Much can be done without destroying index funds
– Limiting Berkshire’s airline ownership does not
destroy index funds
• Prohibiting `JETS’-type sector funds does not conflict
with democratizing investment
– Sector funds concentrate risk, not diversify risk
• Useful e.g. to specialized hedge funds
• Arguably not useful for ordinary households

21. What to do about it
Disclaimer: I have not endorsed and do not endorse
any policy proposal, but was asked to discuss others’
proposals here.

22. What to do
1. Preserve households’ ability to cheaply diversify
2. Enhance investors’ incentives & ability to monitor
3. Preserve or restore competitive product markets

23. Posner - Scott Morton - Weyl proposal
1. Investors <1% of firms can index unrestrictedly
– Largest index fund in the world manages $250bn, < 1% US market
2. Larger funds / families choose one firm per industry
Benefits to consumers & ordinary households
• Restores firms’ incentives to compete
• Concentrated separate holdings improve governance
incentives
• Restriction on “diversification” of institutions is compatible
with households’ ability to diversify
– Households can diversify across funds / fund families

24. Claim: Policy changes would hurt asset owners – even
the smallest investors
• True: investors lose when firms lose monopoly power.
– However, goal of competition policy is not to protect
monopolists, but competition and consumers.
Most households gain much more from lower consumer
prices than from higher equity portfolio values.

25. Summary
• Some sectors are so commonly-owned that
competition is theoretically implausible
– When competition is in no shareholder’s interest, why would firms compete?
• Fast-growing problem in all sectors, worldwide
• Many “critiques” distract from the facts
– Urgent need to devote capacities within competition authorities
• Antitrust enforcement is law enforcement

26. What not to do
1. Wait for structural estimates from all industries
– A properly-executed study takes many years
– Data limitations prevent a study of more than a few
industries
2. Wait for “consensus”