When Goliath Wins: A Dynamic Theory of Firms in Asset Management
Why do investors and managers organize within asset management firms when they can transact directly? I build an equilibrium theory of the asset management firm as a nexus of relationships between investors and managers. Investor capital must be reallocated across managers over time. Outside a firm, each reallocation requires search. A firm can instead reassign investors’ capital across its managers without new search. Because larger firms have more flexibility to reassign, firm value exhibits increasing returns to relationships. Anticipating the need for future reassignment, investors and managers have an incentive to group in large firms. However, joining any firm requires search in the first place, making it hard for firms to grow. Estimated on U.S. firms’ entry, size, growth, and labor share, the model attributes 61% of firm value to the future use of the firm’s relationships, including 25 percentage points from increasing returns to relationships. In counterfactuals, lower search frictions make each relationship less valuable but help firms grow larger, raising the share of firm value from increasing returns to relationships.
