Common Owners as Active Monitors: A Theory of Rational Neglect

Abstract

I propose a novel mechanism of how common ownership affects product market competition. Internalization of shareholders' portfolio interests into managers' objective functions is no longer necessary if owners can provide active monitoring that affects firms' ability to compete. Whenever product market externalities cause common owners to neglect monitoring, firms are less competitive compared to a counterfactual where shareholder interests are aligned with firm value maximization. I formally prove this intuition in a static model of active monitoring with common ownership that allows for heterogeneous firms and portfolio allocations. Based on the game's unique Nash equilibrium, I derive empirical predictions that link unobserved active monitoring to observed product market outcomes. I conclude with a brief analysis of two policy interventions aimed at curbing the anti-competitive effects of common ownership.

Keywords: Common ownership, corporate governance, industrial organization, product markets

JEL Classification: G34, L13