Thursday, April 23, 2015

Institutional investors and widening inequality

Eric Posner and Glen Weyl points to a new paper by Jose Azar, Martin Schmalz, and Isabel Tecu who show how institutional investors like mutual funds reduce market competition and increase prices for consumers. They highlight the fact that a handful of institutional investors have large ownership stakes in the largest firms across industries, thereby raising the possibility of oligopolistic market power. In their paper they use the example of airline industry and write,
Many natural competitors are jointly held by a small set of large diversified institutional investors. In the US airline industry, taking common ownership into account implies increases in market concentration that are 10 times larger than what is “presumed likely to enhance market power” by antitrust authorities. We use within-route variation over time to identify a positive effect of common ownership on ticket prices. A panel-IV strategy that exploits BlackRock's acquisition of Barclays Global Investors confirms these results. We conclude that a hidden social cost - reduced product market competition - accompanies the private benefits of diversification and good governance... airline prices are 3 to 11 percent higher than they would be if common ownership did not exist. 
Posner and Weyl write,
Although we think of airlines as independent companies, they are actually mostly owned by a small group of institutional investors. For example, United's top five shareholders - all institutional investors - own 49.5% of the firm. Most of United's largest shareholders also are the largest shareholders of Southwest, Delta, and other airlines... If a mutual fund owns shares of United and Delta, and United and Delta are the only competitors on certain routes, then the mutual fund benefits if United and Delta refrain from price competition. The managers of United and Delta have no reason to resist such demands, as they, too, as shareholders of their own companies, benefit from the higher profits from price-squeezed passengers... The authors also point out that the investment management company BlackRock is the top shareholder of the three largest banks in the US; BlackRock is also the largest shareholder of Apple and Microsoft. The companies that are the top five shareholders of CVS are also the top five shareholders of Walgreens.  
Since the higher income people own a disproportionate share of the funds in institutional investors like mutual funds, the share of profits accruing to them is far higher. And this excess profits comes from the pocket of consumers, who cover a far wider income spectrum. In other words, these "institutional investors shrink the size of the market while giving the rich a larger share of what's left". The impact of these trends on inequality is unambiguous. 

This is more to the long list of market failures in financial markets. Roger Gordon, Daniel O' Brien and Steven Salop, and Julio Rotemberg have similar papers the role of financial interests and incentives of industrial firms. 

1 comment:

Pratik said...

But if United and Delta are engaging in anti-competitive behaviour (more specifically cartelisation), how can it be that `nothing so obvious is going on' for the competition authority to investigate. If a paper can be written on this, how come the competition regulator cannot use the same data to conclude that United and Delta are engaging in a cartelisation? It seems like a pure competition law issue and the remedy does not lie in securities law. Restricting holding of MFs is not the solution.