Investors’ holdings in multiple firms give rise to what is known as “common ownership.” Are rival firms’ strategic decisions influenced by the presence of common ownership? In this project, BCCP Fellows Melissa Newham (DIW Berlin and KU Leuven) and Jo Seldeslachts (DIW Berlin and KU Leuven), together with Albert Banal-Estanol (Universitat Pompeu Fabra) provide evidence that common ownership can affect market entry, one of the most important strategic decisions firms make, in US pharmaceutical markets.
In 2015, BlackRock and Vanguard were the top two shareholders in Johnson & Johnson, Pfizer, Abbott Laboratories, Perrigo, and Allergan, all among the largest brand or generic drug companies. Common ownership is a pervasive feature not only of pharmaceutical companies, but also of many industries in the US and Europe. While large institutional investors may own at most 5-8% of a single company, this is normally enough to position them as a top investor with privileged access to the firms' management.
Firms that are largely owned by shareholders who also have sizeable stakes in competitors might just simply act in these shareholders' interest, which leads them --rather than maximizing their own profits-- to maximize the return of their shareholders' portfolios. This possibility has led to claims that common ownership is "the major new antitrust challenge of our time" (see Posner et al., 2017).
In this project, the authors analyze the impact of common ownership on market entry. Specifically, they consider generic firms’ entry decisions into drug markets opened up by the end of regulatory protections. Pharmaceutical firms can be categorized as brand or generic firms. Brand firms undertake costly research and development to discover new medications and bring them to market. Generic firms, on the other hand, produce bioequivalent replications of brand drugs at a much lower cost, once the regulatory protections afforded to the brand product expire.
Maintaining monopolized markets is crucial for brand firms. With generic entry, revenues can decline by as much as 90%. Moreover, losses to the brand and gains to the generic are highly asymmetric; brand losses typically exceed what an entrant can expect to gain from entry. Thus, entry decisions may crucially depend on whether owners of generic firms also have an interest in brand firms.
Equipped with a rich database, consisting of 451 drug product markets and 58,737 drug product-brand-generic observations, the authors show that a higher level of common ownership between a brand firm and a potential generic entrant is robustly linked with a lower probability of generic entry. The effect is large: a one-standard-deviation increase in common ownership decreases the probability of entry by that generic firm by 9-13%. They also find that common ownership has an economically significant effect on total generic entry: a one-standard-deviation increase in overall common ownership at the market level decreases the total number of generics in that market by 11-13%.
This research provides evidence that is consistent with the hypothesis that common shareholders indeed influence strategic decisions of companies. Given the importance of generic entry in terms of reducing drug prices and, subsequently, overall healthcare costs, common ownership in the pharmaceutical industry may have the potential to increase what consumers and healthcare providers pay.
The full research paper is available as DIW Discussion Paper 1738 “Common Ownership and Market Entry: Evidence from the Pharmaceutical Industry” as an open access pdf download.