Five hands picking pie chart parts. Market share. Vector illustration

The emerging phenomenon of common ownership, where one (or a group of) large institutional investors, such as mutual funds or hedge funds, own several companies in the same industry poses a number of major challenges to firm executives, competition regulators and policymakers. The potential impact of common ownership on, for example, competition between firms partly owned by the same investors is a serious concern and has widespread implications.

Empirical work in this field investigates the consequences of common ownership but takes the ownership decision as given. A major challenge arises in this case because we know much less about investors’ incentives to become common owners in the first place.

In the paper “Ownership and Competition,”. Alessio Piccolo and Jan Schneemeier take an innovative approach on our way to understand better how common ownership emerges and its impact on societal welfare through competition and risk diversification. The authors endogenize the composition of shareholder portfolios. The paper’s major objective is to investigate to what extent competitive financial markets, where informed (institutional) investors and uninformed (retail) investors interact, lead to socially desirable ownership structures in equilibrium. Doing so, Alessio and Jan answer two questions: (a) whether market forces lead to a balance between undiversified and diversified (i.e., common) ownership; and (b) what are the externalities engendered by common ownership, to other investors and product market consumers.

In the model, an increase in the number of common owners has two distinct effects on their trading returns. First, there is a standard trading effect: more common ownership pushes up the demand for firms’ shares, increasing their price and decreasing common owners’ returns. Second, there is a novel ownership effect: as the fraction of common owners increases, managers of firms owned by these investors internalize spillover effects and compete less aggressively. This generates first order effects on product prices and, therefore, on firm profits. Institutional investors are better informed than retail investors, who lack comprehensive information about firms. As a result, stock prices do not fully reflect the impact of common ownership on firm profits. If this impact is underpriced, the ownership effect increases common owners’ returns; otherwise, it reduces them.

The interactions between these effects provide a number of novel insights. First, when the ownership effect moves against the trading effect and offsets it, there is strategic complementarity among common owners: as common ownership increases, investing in all firms within the same industry becomes more attractive. This incentivizes some of the undiversified investors in the industry to diversify and become common owners. Stated differently, when investors can influence competition, common owners crowd out undiversified investors. What is the immediate consequence of this result? Such crowding out exacerbates the anti-competitive effects of common ownership.

Second, if the ownership effect moves in the same direction as the trading effect, it reinforces the strategic substitutability among common owners. This is likely to happen when common owners are in a powerful position that allows them to tunnel profits from the least to the most efficient firms in the industry. In this case, common owners’ ability to influence competition reduces their returns. The implication is that the level of common ownership in an industry is generally uninformative about their influence on competition.

The main results can be seen graphically in the two graphs below:

The authors proceed to explore welfare implications of common ownership. So far, the literature has argued along two dimensions: diversification benefits and anti-competitive costs, leading to an ambiguous effect of common ownership on welfare. Alessio and Jan show that common ownership may also lead to diversification costs: when tunneling occurs, common ownership increases the volatility of undiversified portfolios and may increase the overall risk borne by investors. Therefore, the existing literature might underestimate the welfare cost of common ownership.

Finally, the model in the paper generates novel empirical predictions. If investors influence competition: (i) there can be complementarities among common owners; and (ii) the volatility of firm profits increases with common ownership. The complementarity is more likely to arise in larger and less concentrated industries (because tunneling is less likely), and implies that common owners’ returns should be larger in industries with more common ownership.

key and wooden Home model on table office. New House, Financial, Property insurance and real estate concepts

What was the exact role that the run in the sale and repurchase (“repo”) market played in the financial crisis of 2008-09 and what can we learn about today’s markets?

While more than a decade has passed since the financial crisis of 2008-2009, and a lot of research has been conducted on the reasons that led to the financial systems fragilities witnessed, there are still some dimensions of that massive crisis that have not been adequately investigated. Learning about them is very useful to avoid such fragilities from developing again in today’s financial markets.

Brittany Almquist Lewis addresses these questions in her recent paper “Creditor Rights, Collateral Reuse, and Credit Supply”. She focuses on a very important mechanism, the exact dynamics of which are still not completely understood: the repo market. Specifically, she asks whether the reuse of private-label mortgage collateral in repo markets, which should have contributed to increasing credit supply to mortgage companies and potentially excessive lending by such companies, created critical interlinkages of financial intermediaries, and led to increased riskiness of the assets underlying the collateral.

An important institutional feature that needs to be understood is that collateral received by a cash lender in a repo transaction can be rehypothecated, that is, the cash lender can reuse it in another, unrelated, transaction. Once the implications of this arrangement are fully understood, we can then trace its impact on the financial system. Specifically, this rehypothecation should have created a multiplier process for collateral, very similar to the money multiplier in the reserve banking system. One important insight of Brittany’s research is that increasing the reuse of private-label mortgage repo collateral led to an increase in, first, credit supply, and, second, through excessive lending ended up contributing to financial instability.

To establish this chain of events, Brittany uses a natural experiment provided by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 that strengthened creditor rights on repo. Specifically, BAPCPA granted preferred bankruptcy status to private-label mortgage backed collateral.

A chain of results are found that strongly point to higher (excessive) lending arising from the reuse of collateral and the subsequent impact on home prices, which were one of the triggers of the financial crisis. First, dealer-banks’ reuse of collateral increases following the introduction BAPCPA, i.e. after the strengthening of repo creditor rights. Second, the money multiplier effect of repo collateral reuse increases credit supply: dealers pass their increased credit supply on to the mortgage companies that they fund by increasing credit lines and loosening the covenants on the credit lines, incentivizing the mortgage companies to originate riskier mortgages. Third, and most importantly, there is causal evidence that during 2005 and 2006, the increased repo credit supply drove up home prices in counties exposed to mortgage originations funded via repo credit lines, and drove down home prices in these areas during 2008, consistent with a financial accelerator effect of repo funding.

The core result, which is the impact of the repo collateral reuse on home prices, is convincingly shown in the graph below which plots the behavior of home prices as a function of county-level market share of independent mortgage companies. Relative to less exposed counties, following BAPCPA counties more exposed to shock to repo markets significantly increased home prices during 2005-2006 and then were those that suffered the most during the 2007-2008 market stress period. The effect is economically significant.

This paper places under the spotlight the unintended consequence that legal or regulatory changes may have on other parts of the financial markets which could end up engendering fragilities in the entire system. In the case of Brittany’s paper, we learn that when overcollateralization requirements differ at each leg of the chain of reuse, increased repo reuse of collateral functions like a money multiplier, creating a positive credit supply shock.

Private equity (PE) has been a constant, and growing, phenomenon in corporate finance over the last three decades and its importance is likely to increase in the post-Covid world as firms will find headwinds after the removal of the many government support programs introduced in 2020.

One industry that has received significant attention from PE funds is the healthcare industry, including hospitals. Perhaps because of the nature of hospitals and their centrality in the provision of healthcare, it is not surprising to witness substantial controversy surrounding the presence of PE funds in this field. Those more favorable to PE funds argue that these investors provide hospitals with much needed funding to invest in new technologies that should ultimately improve patient care and health outcomes. Those who oppose PE funds in this industry claim that the usual behavior exhibited by these investors in other industries – such as higher debt, selling of assets, and layoffs to generate profits – will lead to a negative impact on communities’ access to health care and lower jobs.

Janet Gao, Yongseok Kim, and Merih Sevilir examine this important issue from the point of view of employment, efficiency and patient outcomes at hospitals in their paper “Private Equity in the Hospital Industry”. They compare these outcomes in hospitals acquired by PE acquirers with, first, a sample of non-acquired hospitals, and then, hospitals acquired by non-PE acquirers.

Janet, Yongseok and Merih find that total employment at target hospitals acquired by PE funds significantly declines after acquisition. On the brighter side, the proportion of skilled workers in such acquired hospitals, namely physicians and nurses, in the total workforce increases for hospitals acquired by publicly traded PE funds. These results have to be contrasted with what happens in the case of hospitals acquired by non-PE investors: employment cuts also occur, but skilled worker ratio does not increase in those hospitals. These outcomes, and their magnitudes, can be easily discerned from the graphs below which show how employment and the presence of skilled labor have changed around acquisitions (year 0) made by, separately, PE and non-PE acquirers.

Figure 1: The Figure shows how employment changed in hospitals acquired by PE funds (Panel A) and those by non-PE acquirers (Panel B) after the acquisition (year 0).

Figure 2: The Figure shows how the ratio of skilled workers (physicians and nurses) over total employment changed in hospitals acquired by PE funds (Panel C) and those by non-PE acquirers (Panel D) after the acquisition (year 0).

Perhaps because of the higher presence of skilled workers in PE funds-acquired hospitals that the authors also observe another important finding: patient satisfaction scores do not decline at PE-acquired hospitals and even improve along some dimensions after such acquisitions. Also, PE acquirers are not associated with higher mortality and readmission rates at target hospitals compared to non-PE acquirers.

This research provides new evidence on the role of PE acquirers in the hospital industry and paints a more nuanced picture with the differences between PE and non-PE acquirers, as well as between PE-backed acquirers with and without access to public capital markets.