Empirical Findings in Need of a Theory – In Defense of Institutional Investors

In recent years, the hallmark of institutional investors' business strategy has been under attack. Theorists have forcefully argued that institutional investors' diversification harms competition. The theory is that when portfolio firms are cross owned by institutional investors, the firms' respective managements compete less vigorously than they would have but for cross ownership, to the detriment of product market consumers. Empirical findings bolstering this ostensibly straightforward theory of competitive harm were soon contested by numerous commentators on methodological grounds. But the theory of competitive harm it-self remains unchallenged, and is considered infallible. The federal anti-trust agencies and competition agencies across the Globe have begun to take action against instances of cross ownership based on this uncontested theory, in what has been described as an attack on the entire system of mutual fund holdings. This Article resolves the mismatch between theory and the most recent empirical findings. The Article develops a novel understanding of cross ownership and its effects on portfolio firms' conduct. It challenges the theory of competitive harm, and shows that institutional investors' common ownership cannot adversely affect portfolio firms' competitive conduct. Moreover, the Article shows that cross ownership actually safeguards against competitive harm of the kind en-visioned by the recent literature. The novel theory developed in this Article is not only a solution to a perplexing academic puzzle. Its policy implications are far reaching. The theory reveals that recent enforcement measures against instances of cross ownership are socially harmful. They unduly deny investors the long-acknowledged benefits of diversification and disrupt the functioning of capital markets. These enforcement efforts should be abandoned as swiftly as they were initiated