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E-MailEiner Elhauge is the Petrie Professor of Law at Harvard Law School. This post is based on Professor Elhauge’s recent article.
Horizontal shareholding exists when major shareholders own stock in horizontal competitors. A year ago, I argued that such horizontal shareholding can have worrisome anticompetitive effects that help explain various puzzles about our economy (this article was discussed on the Forum here). In a new article, I show that new evidence both confirms my earlier conclusions and indicates the problem of horizontal shareholding is getting worse.
This new data reveals that horizontal shareholding levels have grown sharply in recent years. From 1999 to 2014, the odds that two competitors have a common shareholder with more than 5% of the stock of each of them rose from 16% to 90%. In other word, take any two random competitors, and the odds are now 90% that they each have a common major shareholder whose profits will suffer if the firms compete with each other for market share.
This sharp rise in horizontal shareholding since 1999 helps explain many economic puzzles. First, why is executive compensation based in large part on industry performance, even though Holmström’s Nobel prizewinning work has long proven it would be efficient to filter out industry performance and base incentive compensation only on the performance of the executive’s firm relative to other firms? Horizontal shareholding explains this puzzle, because basing executive compensation in part on industry performance maximizes the profits of horizontal shareholders who have shares across the industry.
I previously pointed out that the horizontal shareholding explanation best fits the empirical evidence showing that: (1) in less competitive markets, executive compensation is based more on industry performance and less on firm performance; (2) executive compensation has become increasingly based on market performance since the 1990s, which coincides with the dramatic rise in horizontal shareholding since then; and (3) large institutional investors voted against proposals to make executive compensation based more on individual corporate performance.
Now we also have direct empirical proof that the problem is linked to horizontal shareholding, with new regression analysis showing that, in markets with higher horizontal shareholding levels, firms compensate executives “less for their own firm’s performance and more for their rival’s performance.” The statistical confidence level of this finding is over 99 percent. This empirical finding precisely fits what a new proof shows would maximize the interests of shareholders who are partly horizontal. It also provides a clear mechanism for how horizontal shareholders influence corporate management.
Second, why has corporate investment has been so low in recent years despite high corporate profits? Another Nobel prizewinner, Paul Krugman, argued that the likely explanation was increased market power, but that begged the question: what was causing this increase in market power that was going unpoliced by current antitrust law? I argued that rising horizontal shareholding could help explain this phenomenon, because horizontal shareholding would increase profits by reducing output, and lowering output requires less corporate investment.
New empirical strongly supports this conclusion. To begin with, it confirms that the historically high gap between corporate investment and profits started in 2000, just when the recent sharp rise in horizontal shareholding started. More important, a new regression directly shows that the investment-profit gap is driven by the level of horizontal shareholding in concentrated markets. This new empirical evidence now affirmatively establishes a link between anticompetitive horizontal shareholding and the economy-wide lack of corporate investment that has contributed to low economic growth in recent decades. This new evidence also indicates that the driving cause cannot be general macroeconomic, technological or policy trends, such as recessions, increased automation, decreased productivity, a slowdown in technological innovation, or changes in government spending, taxes or labor law. If such general trends were the cause, they should result in a profit-investment gap across the economy; they cannot explain why the gap is instead driven by concentrated markets with high horizontal shareholdings.
Third, why has economic inequality increased in recent years? Nobel prizewinners like Joseph Stiglitz and Paul Krugman have suggested that part of the explanation is increased anticompetitive practices, but again that begs the question: what is causing this increase in anticompetitive practices despite our antitrust laws? I suggested that horizontal shareholding could help explain the phenomenon because it was rising and was the one anticompetitive problem we were literally doing nothing about.
New evidence again supports my conclusion. During the same 1999-2014 period when the probability that two competitors had a large common shareholder went from 16 percent to 90 percent, we have had the highest growth in corporate profits and greatest decline in labor’s share of national income since World War II. Further, the empirical study showing that horizontal shareholding in concentrated markets has driven the gap between high corporate profits and low corporate investment also confirms a connection to economic inequality. The reason is that those high corporate profits go to shareholders who are disproportionately wealthy and reflect high prices that are disproportionately borne by the non-wealthy, and the lack of corporate investment depresses employment and wages in a way that also disproportionately harms the non-wealthy.
New empirical evidence also validates two important industry studies that have confirmed horizontal shareholding increased prices in the airline and banking industries. These studies have been subject to various critiques, many funded by institutional investors with large horizontal shareholdings, which helpfully assures that there has been a well-funded and strongly motivated effort to uncover any flaws in those studies. As I detail in my new paper, those critiques are either misguided in theory or, when taken into account, actually indicate the anticompetitive effects are even stronger than previously found.
The cross-industry regressions showing that horizontal shareholding explains our inefficient methods of executive compensation and high investment-profits gap also provides important evidence that the problem with horizontal shareholding generalizes beyond the two industries in which anticompetitive effects have been directly proven. And all these empirical studies just confirm what economics would predict given the structural incentives created by high levels of horizontal shareholding.
Luckily, the problem of horizontal shareholding has a straightforward solution. The Clayton Act already bans any stock acquisition that substantially lessens competition. When horizontal shareholding creates anticompetitive effects, the stock acquisitions that created those horizontal shareholdings substantially lessen competition and thus violate the plain meaning of the Clayton Act. The solely-for-investment “exception” is not to the contrary because: (1) it requires a lack of influence that institutional investors typically do not satisfy; and (2) it is not actually an exception, but rather provides that investor passivity triggers a requirement to show that the substantial lessening of competition was intended or actually occurred (whereas without investor passivity, it suffices to show such anticompetitive effects “may” occur).
In short, new evidence not only confirms the problem of horizontal shareholding, but shows the problem is growing and central to major economic concerns facing our nation. Horizontal shareholding clearly remains the biggest anticompetitive problem we are doing nothing about. But it has a straightforward solution. All we need is the will to enforce the antitrust laws we already have on the books.
The complete article is available for download here.
