MIT Sloan professor finds common ownership of firms impacts their disclosure policiesDisclosure incentives increase as cost of capital decreases
CAMBRIDGE, Mass., Feb. 19, 2019 – Consolidation in the asset management industry and the rise in mutual fund investing have led to a small number of institutional investors becoming the largest shareholders of most publicly-traded firms in the U.S. This raises important questions about the impact of common ownership on firm behavior, particularly firms’ disclosure of information like earnings forecasts and capital expenditures.
A recent study by MIT Sloan School of Management Prof. Nemit Shroff found that firms with common owners are more likely to disclose information. This benefits common owners by reducing the cost of capital and increasing liquidity. “Over the past 30 years, public firm stock owned by large institutional investors has substantially increased and become more concentrated,” said Shroff. “For example, Black Rock and Vanguard are among the largest five shareholders of more than 53% of Compustat firms. In 2015, almost 70% of firms in the U.S. were commonly owned. Given the pervasiveness of common ownership in today’s economy, it is important to understand the consequences of common ownership on firm behavior.”
To shed light on these consequences, Shroff and his colleagues looked at the effect of common ownership on firms’ disclosure decisions. He explains, “Traditionally, firms would have separate owners and compete against each other. As competitors, they wouldn’t want to tip their hands by disclosing too much information about things like forecasted profits and investments. However, what happens when the same investors own both firms and their competitors? Does common ownership change their behavior and provide incentives to disclose more information?”
Prior research suggests that managers of co-owned firms behave in ways to increase the portfolio value of the common owners. If they are less competitive with each other, they may be less concerned about sharing proprietary information in their disclosures. Previous studies also provide evidence that greater disclosure by one firm in an industry can have spillover effects related to liquidity and cost of capital for other firms in that industry. Thus, common ownership could create incentives for firms to increase disclosure, notes Shroff.
In his study, the researchers looked at firms where one of the investors simultaneously owned a stake larger than five percent in at least two firms in the industry. As all public companies are required to make certain minimum disclosures in the U.S., they examined voluntary disclosures above and beyond that minimum. They used three disclosure proxies that are all useful to the market but differ in the degree to which they reveal proprietary information: earnings forecasts, capital expenditure forecasts, and redacted disclosures. Their sample included 54,541 U.S. public firm observations from 1999 to 2015.
They found that common ownership increases firms’ voluntary disclosures. More specifically, the data showed that common ownership increases disclosure of earnings forecasts by 8.8% and disclosure of capital expenditure forecast by 12.9%. However, common ownership does not impact the extent to which firms redact sensitive information from contracts.
“Our inference is that common ownership leads to more disclosures because firms are less concerned about proprietary costs and consider the spillover benefits that they have on other firms. However, common ownership doesn’t lead firms to disclose the most sensitive information because there is still competition from firms outside of the common owner’s portfolio,” says Shroff.
The study also revealed that the greater the degree to which firms in an industry have a common owner, the larger the effect of common ownership on disclosure. He explains, “When there is a lot of common ownership in an industry, even the extent to which firms redact information from contracts reduces.”
Another finding was that firms increase disclosure in response to a loss of public information for co-owned peer firms. “This finding suggests that common ownership motivates firms to consider the spillover benefits of their disclosures for their co-owned peers. The spillover benefits of disclosure increase when a firm loses public information, motivating other firms in the common owners’ portfolio to increase disclosure” says Shroff.
He points out that there are significant benefits for investors from common ownership. “It helps reduce transaction costs and increases stock liquidity. It also leads to greater transparency about firms’ practices, which provides investors with better insights about firms. While common ownership is known to be bad for consumers, investors have a silver lining.”
Shroff is a coauthor of “Disclosure incentives when competing firms have common ownership,” which was accepted for publication at the Journal of Accounting and Economics.