In recent years, financial regulators around the world have been sounding alarm bells on a phenomenon known as “common ownership”, which refers to shareholders holding shares in companies that compete in the same sector. They fear that such corporate cross-ownership hurts competition as companies will have fewer incentives to invest in new products or services, or to win market share from competitors, if they know that their large shareholders also own significant stakes in their rivals.
What’s more, as institutional investors own a portfolio of firms, they usually aim to maximise the value of their whole portfolio, rather than that of an individual investee company. As such, sometimes these investors may make decisions that may not be optimal for individual firms within the portfolio.
For example, institutional investors often vote for mergers despite negative acquirer announcement returns because they also hold substantial stakes in the target company and make up for the losses from the acquirers with the gains from the targets.
However, new research from Associate Professors Holly Yang and Young Jun Cho from Singapore Management University’s (SMU) School of Accountancy found that common ownership of industry peers helps institutional investors acquire industry insights and produces exclusive information that managers can obtain from stock price movements. Managers can then use this information to make better operational and investment decisions.
“Overall, our results suggest that cross-ownership of peer firms induces more efficient corporate decisions by helping prices better reflect investors’ private information,” says Prof Yang.
Gaining industry insights through price
The SMU study is based on the theory of financial markets, which suggests that managers can glean information from stock price about their own firms, as stock price contains information from traders that managers do not have.
While researchers often assume that information generally flows from the company to the market, this theory suggests that information can also go in the other direction.
According to the SMU research, this information flow is enhanced when cross-ownership is concentrated in a set of firms in the same industry. This sometimes enables management of affected companies to gather more easily industry insights from price movements, leading to better decision making and more accurate profit forecasts.
“The traditional view is that managers always have more information, but that’s not necessarily true. A manager may have more firm-specific information but less industry-specific information. Institutions, by investing in multiple peer firms in the same industry, may have information about demand from product markets or strategic issues relating to the firm’s competitors,” explains Prof Yang.
“As a result, they are likely to have a better understanding of industry trends and the overall competing landscape. This information is reflected in stock prices through institutional trading.”
For example, when digital photos replaced films and smartphones replaced cameras in the early 2000s, Fujifilm was not only able to identify new business lines using its existing photo film technologies, but also invest heavily in R&D to diversify away from its traditional film production business.
On the other hand, Kodak failed to react fast enough to the threat of new technology and eventually filed for bankruptcy in 2012. A common owner of these two industry leaders at that time would be able to identify the different management strategies adopted by the two rivals and use that information to their advantage in their trades.
Such industry insights matter to firms and investors since corporate decisions are determined not only by internal information on firm fundamentals but also by external factors, such as industry prospects, says Prof Yang.
For example, if Softbank’s holdings in AI firms allows them to generate industry insights and leads to more investments in driverless cars, then the share price of automobile stocks are likely to go up. Car manufacturers are then likely to increase their capital expenditures in similar projects as this information is also priced into their shares. Likewise, they may also revise their earnings projections to reflect their expectations of product demand.
The SMU study breaks new ground on the ongoing debate over whether common ownership is desirable or not in financial markets. A lot of the recent discussion on the topic has focused on anti-trust issues, and there have even been suggestions of imposing a limit on the percentage of shares institutional investors can hold in a particular industry, or restricting them to owning only one company in each industry.
Says Prof Yang: “While it’s premature to say whether common ownership is net beneficial to the society, our findings shed light on one of the benefits of cross-ownership that hasn’t been explored.”
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