The Perils of Common Ownership: The Flooding Phenomenon

51 Pages Posted: 30 Dec 2019 Last revised: 21 Jan 2020

See all articles by Danielle Chaim

Danielle Chaim

Columbia University, Law School, Students

Date Written: December 31, 2019

Abstract

The increased concentration of shares in the hands of large institutional investors has triggered a phenomenon that I term “flooding.” The term is apt because, under this phenomenon, institutional investors push their portfolio firms towards higher levels of noncompliance. When coupled with limited enforcement capabilities, the increase in the levels of noncompliance reduces the probability that such behavior will be detected and adequately penalized. Without adequate measures in place to stem the flow, noncompliance, at first a trickle, gathers the force of a flood. The presence of large, diversified shareholders is, in fact, a disaster for the inherent trade-off between compliance and enforcement. Misconduct becomes less risky and more rewarding, changing the way in which public firms approach legal risks.

Data suggests that the emerging ownership pattern in the United States increases levels of corporate tax avoidance. In this Article, I argue that this increase creates the described flooding effect, overwhelming the tax agency, which subsequently faces new enforcement challenges. I identify linkages between characteristically passive institutional ownership and tax noncompliance, while emphasizing that neither direct communication between institutional investors and managers of portfolio firms, nor coordination or collusion between corporate managers, is necessarily required for flooding to occur. Finally, I propose a double sanctions regime under which institutional investors will be penalized for the tax avoidance behavior of their firms. Such a regime will moderate the incentive for public corporations and their institutional shareholders to engage in higher levels of tax avoidance.

Keywords: Common ownership; Institutional investors; Corporate governance; Corporate tax avoidance; Compliance

Suggested Citation

Chaim, Danielle, The Perils of Common Ownership: The Flooding Phenomenon (December 31, 2019). Available at SSRN: https://ssrn.com/abstract=3502717 or http://dx.doi.org/10.2139/ssrn.3502717

Danielle Chaim (Contact Author)

Columbia University, Law School, Students ( email )

435 West 116th Street
New York, NY 10025
United States

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