In recent years theorists have argued that institutional investors’ diversification harms competition. The theory is that when portfolio firms are cross-owned by institutional investors, managements compete less vigorously than they would have but for the cross ownership. The theory was bolstered by several empirical studies. The supporting empirical studies have been contested on methodological grounds, and some recent empirical studies make contradicting findings. But the theory of competitive harm itself is still considered persuasive. The federal antitrust agencies and competition agencies across the globe have begun to take action against instances of cross ownership based on this theory, in what has been described as an attack on the entire system of mutual fund holdings. This Article resolves the mismatch between theory and the most recent empirical findings. The Article develops an understanding of cross ownership and its effects on portfolio firms’ conduct. It challenges the theory of competitive harm, and shows that institutional investors’ common ownership cannot adversely affect portfolio firms’ competitive conduct. Moreover, the Article shows that cross ownership actually safeguards against competitive harm of the kind envisioned in the literature. The theory developed in this Article suggests that enforcement measures taken against instances of cross ownership are socially harmful. They unduly deny investors the long-acknowledged benefits of diversification and disrupt the functioning of capital markets. These enforcement efforts should be abandoned as swiftly as they were initiated.
Ittai Paldor, Empirical Findings in Need of a Theory—in Defense of Institutional Investors, 54 Loy. L.A. L. Rev. 785 (2021).