Portfolio Diversification, Market Power, and the Theory of the Firm

Abstract

This paper develops a model of firm behavior in the context of oligopoly and portfolio diversification by shareholders. The management of each firm proposes a strategic plan to shareholders, and is evaluated based on the strategic plan. This leads to internalization and aggregation of shareholder objectives, including holdings in other firms, and situations where consumers/workers are also shareholders. When all shareholders hold market portfolios, firms that are formally separate behave as a single firm. I introduce new indices that capture the internalization effects from consumer/worker control, and discuss implications for antitrust, stakeholder theory, and the boundaries of the firm.

Keywords: Common Ownership, Theory of the Firm, MHHI, Oligopoly, Stakeholder Theory, Firm Boundaries

JEL Classification: L41, L10, G34