The Winner's Curse

October 29, 2012


Much ink has been spilled on the perils of allowing some companies to become "too big to fail." This sentiment assumes that governments, hence taxpayers, must foot the bill when these top dogs become seriously ill, while reinforcing a view that the top dogs, whose failure might do systemic damage, should be heavily regulated to mitigate the damage that they might cause. The flip side of this view receives scant attention: Companies can become "too big to succeed."

Indeed, the "too big to fail" ethos may create head winds for these self-same companies that can impede their continuing success. When you are No. 1, you have a bright bull’s-eye painted on your back. Governments and pundits are gunning for you, as are competitors and resentful customers. In a world that generally roots for the underdog, hardly anyone outside of your own enterprise is cheering for you to rise from world-beating success to still-loftier success.

For investors, top dog status—the No. 1 company, by market capitalization, in each sector or market—is dismayingly unattractive. We find a statistically significant tendency for top companies in each sector to underperform both the overall sector and the stock market as a whole. In an earlier U.S.-only study, we found that 59 percent of these top dogs underperformed their own sector in the next year, and two-thirds lagged their sector over the next decade. We found a daunting magnitude of average underperformance, averaging between 300 and 400 bps per year, over the next one to 10 years.

In this study, we have broadened the test to examine whether the "top dog" phenomenon is prevalent elsewhere. We find the same phenomenon in each and every market, with no exceptions. Indeed, outside the United States, the sector top dogs generally underperform their own sector even more relentlessly than in the United States!

It would appear that our top dogs, the most beloved and winningest companies in each sector or country, are typically punished—often severely—in subsequent market action.

Bubble, Bubble, Toil And Trouble
During the global financial crisis, several bellwether institutions found themselves facing insolvency. Government agencies, worried that these companies were "too big to fail," creating systemic risk for the market at large, reached for the elixir of public money to bail out these institutions, while reinforcing a view that stricter federal oversight is necessary to prevent the negative externalities created by large companies.

In the meantime, the widespread criticism over the "too big to fail" policy inevitably invites an exploration of the other side of the coin: the question of whether or not companies can become "too big to succeed."

Running a large business is not easy. As companies increase fixed costs, they often sacrifice the flexibility to respond nimbly to unforeseen challenges; they have more internal and external distractions; internal rivalries can derail growth; they can become the prey of smaller competitors, who are constantly innovating, in an attempt to slice vulnerable niche opportunities out of the top dogs’ market share. The innovations that can loft a smaller competitor to new heights will barely move the needle for their top dog rivals.


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