Introduction

Previous studies suggest that institutional ownership keeps growing in U.S. stock markets and has an important role in both corporate strategy and equity pricing (e.g., Allen, 2001; Gompers and Metrick, 2001; Bethel et al., 2009; Rydqvist et al., 2014; McCahery et al., 2016). Institutional investors manage portfolios that are not only much greater in financial terms than those of most retail investors, but also contain much larger numbers of stocks.1 Compared to retail investors, there is a much higher probability that institutional investors will become owners of the stocks on both sides of a proposed merger deal – i.e., they hold shares in both the acquirer and the target. In the context of mergers and acquisitions (M&As), this is termed an “institutional cross-holding.” In this paper, we investigate the externality of institutional cross-holdings for corporate strategies through an important corporate event: M&As. Unlike non cross-owners, who only hold the stock on one side of a merger deal, cross-holders tend to make decisions from a broader perspective that nets off any potential losses from one side (usually the acquirer) with gains made on the other (usually the target) and will consider how the newly formed joint entity would sit within their portfolios compared with the two existing separate stocks. Therefore, cross-holders may have different information sets, different incentive structures and may make different choices than those that would have arisen for single stock holders of either acquirers or targets. Furthermore, institutional cross-owners may have an important governance role in the M&A process, reducing information asymmetry and mitigating the bargaining and transaction costs that would normally arise between entirely independent parties.2 Understanding whether and how institutional cross-ownership affects M&A decision making and deal outcomes are, by themselves, of particular importance. Empirically observing the effects of institutional cross-holdings on intercorporate activities is extremely difficult because the bulk of these activities takes place behind closed doors. Moreover, it is difficult to separate the impact of institutional investor activism from the myriad of other factors that could have caused the same outcomes.3 M&A events present a natural arena within which to test the effect of cross-holdings on corporate strategy since they represent identifiable events and cross-holdings are observable in both acquirers and targets. Cross-owners may be actively involved in the M&A decision-making process because these deals have substantial impacts on the wealth of both acquirers and targets.