Definitions and theory
Market concentration is a measure of the extent to which a given market is divided between competing firms. Where there is a high degree of market concentration, the market in question will be dominated by a small number of firms. According to the Organisation for Economic Co-operation and Development (OECD), a global increase in market concentration in recent years has raised concerns that the growth of large firms can present a risk to competition. Concentrated markets have been linked to a decline in labour share, low productivity growth and investment, high prices and markups, and rising inequality. Recent Treasury research suggests that weaker competitive pressures may be a cause of Australia’s productivity slowdown.
On this measure, more than half of Australia’s markets are concentrated, and concentration in the Australian economy is on the rise. In Australia, a small number of firms dominate in the banking, supermarkets, mobile telecommunications, internet services provision, energy retailing, gas supply and transport, insurance, pathology services and domestic air travel industries.
‘Common ownership’ is used to describe a situation in which investors own shares in competing businesses. In academic and policy literature, common ownership is sometimes also described as horizontal or overlapping shareholding. This phenomenon is said to occur most frequently when institutional investors diversify their holdings by obtaining shares in different firms across an industry, which allows them to reduce their exposure to risk associated with individual firms.
This is the strategy of institutional or passive and lazy capital, the situation where a small number of investors owning shares in rival firms can lead to a reduction in the amount of competition in the marketplace. This is problematic because Australian entrepreneurs and start-ups have complained for many years of being starved of capital, and indeed many of our most innovative firms such as Atlassian left Australia both for lower taxing environments and to raise capital. The Australian Competition and Consumer Commission (ACCC) explains:
Competitive, informed and (when necessary) well-regulated markets lead to lower prices, better quality products and services, and more choice. This increases the prosperity and welfare of all Australians.
The theory of common ownership describes the harmful effect that this ownership structure can have on market competition. The theory suggests that because investors have an incentive to maximise the total value of their holdings, investors who own rival businesses may tolerate less competition between their businesses. Reduced competition would allow these investors to maintain high prices of goods or services, while lessening the need to invest in innovation, marketing campaigns, or business improvements.
In a 2021 study ‘Common Ownership of Competing Firms: Evidence from Australia’, Dr Andrew Leigh—the Deputy Chair of the committee—and Dr Adam Triggs from the Australian National University noted that the problem of common ownership can be most easily illustrated by reference to the case of a duopoly—a situation where a single market is entirely shared between two large firms:
If both firms have separate owners, it is in each firm’s interest to maximise its own profits. If the two firms are wholly owned by the same person, then it is in the financial interest of the owner for both companies to behave like a monopoly: aiming to maximise joint profits. In the presence of a common owner, the firms are more likely to costly divide the market than they are to embark on a risky price war.
In such a situation, common ownership would be beneficial for the owner, who will achieve higher profits by increasing prices, lowering investments in innovation, coordinating wage policies and reducing the need to lower operational costs. This is detrimental for consumers, who may be forced to accept lower quality service, less innovative products, and higher prices. Employees of businesses with common owners may also be adversely impacted through lower remuneration.
While collusion between competing firms is prohibited by law in Australia, common ownership—with its potential to reduce incentives for competition—can result in a type of indirect collusion, which can be difficult to capture and regulate. In his testimony before the committee, Associate Professor Martin Schmalz from the Saïd Business School at the University of Oxford drew a distinction between the concepts of collusion and common ownership:
Collusion is where you have two firms that both want to maximise their own value or their shareholders want to maximise the value of their individual firms. They face this problem which is that they have incentives to compete. They have incentives to undercut each other's prices in order to innovate and to steal market share from the other. The problem is that the other firm will do the same, and they will compete until they make minimal profits. That is of course great for society … [b]ut it's not the greatest outcome for the shareholders. The shareholders would do much better if these incentives to compete were somehow blocked, and collusion is a way of doing that—that's the smoke-filled backroom, where one just decides, 'Look, the price of bread shall be six pounds henceforth'—and then the firms have incentives to undercut this collusive price, and there needs to be a mechanism by which that doesn't happen and so forth. That's the theory of collusion.
The theory of common ownership is exactly the opposite. It says: 'Look, the owners of two bakeries can just swap 50 per cent of their shares, then both of them hold 50 per cent in both bakeries, in which case they don't have any incentive to undercut the six-pound price anymore. They don't need collusion. They don't need a mechanism that sustains the collusion. You just took away the incentive to undercut the price and innovate in the first place.'
These related phenomena of common ownership and capital concentration carry potential risks for the Australian economy. Accordingly, the government has an important role to play in ensuring that any such risks can be correctly identified, and appropriately addressed.
Rising interest in common ownership: Why now?
The interest in common ownership and its potential impact on competition has a long historical lineage.
Adam Smith once cynically claimed that ‘people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.’ Ever since, modern governments have sought to protect consumers and broader society from such conspiracies.
In the 1880s, owners of railway and banking companies in the United States sought to maximise their profits by setting up ‘trusts’, which served to pool the ownership of these firms, influence the election of their directors, and ultimately dampen competition. Such anti-competitive behaviour triggered the creation of the Sherman Antitrust Act of 1890—the first legislation enacted by the United States Congress to outlaw monopolistic business practices.
Over the past decade, there has been a renewed focus on common ownership and its potential impact. While this area has been a subject of extensive research, the questions of evidence and methodology used to identify and analyse the impact of common ownership remains subject to debate. There is also a lack of consensus around the question of whether and how institutional investors are able to influence the actions of competing companies in which they hold an ownership stake.
Scholarly interest in this area has been driven by the rise of institutional investors, and particularly index (or passive) investment funds. Index funds are often highly diversified, with shares owned in many businesses across the same industries. They are managed ‘passively’ in the sense that they seek to match the performance of a benchmark index, unlike actively managed investment funds that aim to outperform the market. Index funds allow investors to build diversified portfolios at a lower cost, as they avoid the need for the expensive research and analysis that underpins active funds, and as a result can offer lower management fees.
The popularity of index funds has risen substantially in the aftermath of the Global Financial Crisis. At the beginning of 2018, the world’s four largest index funds—BlackRock, Vanguard, State Street and Fidelity—managed over $16 trillion in assets. Moreover, the largest shareholder for 88 per cent of firms on the S&P 500 Index (which tracks the performance of 500 large companies listed on stock exchanges in the United States) was one of those four asset managers. While index funds adopt ‘passive’ investment strategies, there is evidence to suggest that they are actively engaged in the corporate governance of the businesses within their portfolios. Fund managers regularly engage with businesses as part of their standard stewardship activities, but the nature of this engagement and its potential to influence the behaviour of businesses has been the subject of significant debate.
Where large index funds can exercise powers associated with common ownership, consumers can lose out. Ascertaining the specific impact of such a situation on Australian households is quite complex. As consumers, households are adversely impacted if businesses are not incentivised to compete in providing goods and services. On the other hand, as investors, households benefit from low-cost, high-yield investment returns provided by strong-performing index funds. This situation raises questions about the overall impact of common ownership, and whether policymakers ought to do something in response.
Australia faces the added risk of the power concentrated within superannuation funds which, if they continue to grow at their current rate, will soon be larger than the value of the entire Australian share market.
Current research into common ownership and its impact
To date, most research into common ownership has focused on the United States. Recent studies have found that the level of common ownership in publicly listed American companies has been on the rise. According to one study, ‘the fraction of US public firms held by institutional investors that simultaneously hold at least 5% of the common equity of other same-industry firms had increased from below 10% in 1980 to about 60% in 2014.’
These studies have also pointed to the link between common ownership and anti-competitive behaviour, leading to higher prices. For example, economics and finance researchers José Azar, Sahil Raina and Martin Schmalz analysed fees for banking deposit services and found that common ownership was associated with higher fees. A subsequent study by Azar, Schmalz and Isabel Tecu focused on the domestic airline industry in the United States and showed that common ownership was associated with higher prices, which were approximately 3 to 12 per cent higher on average than would be the case under separate ownership. Similar trends have been identified in the fields of commercial banking, pharmaceuticals, breakfast cereals and soft drinks.
In 2017, the OECD held an event that focused on the problem of common ownership. The event’s background paper noted that similar trends are evident in Europe, including in the banking sector, and in areas such as the German chemical industry and the Icelandic real estate, insurance and telecommunications sectors.
Leigh and Triggs offered the first estimate of the extent of common ownership of competing firms in Australia and its impact on market concentration. The study found that among firms where at least one owner could be identified, 31 per cent share a substantial owner with a rival company. In analysing 443 industries, Leigh and Triggs identified 49 that exhibited common ownership. These include commercial banking, explosives manufacturing, fuel retailing, insurance and iron ore mining. Across the Australian economy, the authors argued, common ownership increases effective market concentration by 21 per cent.
In their submission to the committee inquiry, Associate Professor Martin Schmalz and Thomas Reyntjens from the University of Oxford noted that the research by Leigh and Triggs indicates that when accounting for common ownership, industries in Australia exhibit a high level of concentration. Furthermore, they suggested that common ownership in Australia is likely to increase in the future:
OECD data shows that more than a quarter of shares in Australian listed companies are held by institutional investors, comprising mostly mutual funds, pension funds and insurance companies. Such institutional investors increasingly adopt passive investment strategies, whereby they track an index of shares (for example, the ASX200 or industry-specific indices). Competitors are often part of the same index, such that an increase in index investing leads to an increase in common ownership—and as institutional investment and index investing have globally been on the rise the past decades the likely future trajectory of common ownership in Australia is an increasing one.
Forming effective response
Leigh and Triggs emphasised in their study that their research does not offer ‘direct evidence of nefarious behaviour by common owners of Australian firms,’ while several witnesses who supported this inquiry expressed similar views. The ACCC, for example, noted that in monitoring the phenomenon for the past two years, it had not identified any complaints of common ownership having a negative impact. It is important to note that the ACCC only became aware of this framework in the last 18 months. Leigh and Triggs have additionally argued, however, that it is critical to better understand the extent of common ownership in Australia, and the ways in which such ownership has the potential to reduce competition, noting that:
Just as monopolies can harm consumers without breaking the law, common ownership does not require foul play for consumers to be left worse off.
The ACCC has further observed that:
… you get a problem from the combination of common ownership of competitor companies and only a few competitor companies of any size in each sector. You can see in most sectors in Australia that there are only a couple of companies—two, three or sometimes four in the case of banks—and, when you get two, three or four well-established companies, often they are not competing vigorously with each other for one reason or another. Then when you get concentration in wealth management you could find that you have that common ownership of a small number of competitors, and that is where the problem arises.
Context and scope of the committee’s interest
The committee shares the concern that common ownership and increasing concentration can have potentially adverse effects upon the Australian economy. In particular, the committee believes that these phenomena should be better understood and more closely monitored, given the rise in popularity of index funds and the amount of wealth managed by superannuation funds in Australia.
This inquiry has focused on outlining the current level of common ownership and capital concentration in Australia. In undertaking this inquiry, the committee has also considered mechanisms that would allow for the collection of comprehensive, accurate and easily accessible data to measure and track these phenomena. The committee has sought to better understand research that has been undertaken into so-called transmission mechanisms through which common owners might exert their influence, with a particular focus placed on voting practices, investors’ engagement with the management of companies, and management remuneration. In undertaking this inquiry, the committee has also explored current legislative and regulatory frameworks relevant to common ownership and capital concentration, and proposed a set of recommendations aimed at implementing effective responses to these phenomena.