The Strategies of Anticompetitive Common Ownership

Scott Hemphill is Professor of Law and Marcel Kahan is George T. Lowy Professor of Law at New York University School of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Horizontal Shareholding (discussed on the Forum here); and New Evidence, Proofs, and Legal Theories on Horizontal Shareholding (discussed on the Forum here), both by Einer Elhauge; and Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here).

Institutional investors, such as large mutual funds, often own significant stakes in competing firms. Antitrust theorists have long suggested that common concentrated owners (“CCOs”) have interests that differ from those of owners of a single competing firm and might be able to induce firms in which they hold a stake to further these interests. Recently, empirical evidence indicates that CCOs are associated with various anticompetitive effects. The most important article in this literature is an empirical study of the airline industry that concludes that common ownership of competing airlines, evaluated at the route level, is associated with higher prices on that route.

This new evidence, and the dramatic growth in institutional investors over the last several decades, have stimulated a major rethinking of antitrust enforcement. The Department of Justice, the Federal Trade Commission, and the European Commission have each, to varying degrees, conducted hearings and investigations or expressed concerns about common ownership. Academic commentators have advocated measures that go much further. They urge that funds must cease their ownership of competing firms, shrink to a fraction of their current size, or lose the right to vote their shares in their portfolio companies. These proposals, if adopted, would transform the landscape of institutional investing.

Missing from the debate thus far is a systematic explication and assessment of the causal mechanisms that might link common ownership to higher prices. Yet such an inquiry is important for several reasons. The absence of a plausible mechanism that generates the observed results would raise doubts about proponents’ preferred interpretation of the statistical relationship between market outcomes and common ownership. Moreover, a finding that only certain types of investors can plausibly avail themselves of the mechanism would suggest narrower, more targeted reform proposals and enforcement actions, as well as targeted investigations to uncover direct evidence of CCOs influencing corporate policy.

Our new study, The Strategies of Anticompetitive Ownership, is an effort to fill that gap. We identify a wide range of potential mechanisms linking common ownership to anticompetitive effects and evaluate each using two criteria. First, is the mechanism tested by the empirical literature—that is, would its use generate the observed empirical results? Second, is the mechanism plausible, in the sense that it is the mechanism feasible, effective, and in a CCO’s economic interest?

Our evaluation of mechanisms yields three main results. First, some widely discussed mechanisms are, in fact, not tested through the methodology employed in the empirical literature. Specifically, almost the entire empirical evidence on the effect of common concentrated ownership is limited to mechanisms that entail a conflict between CCOs and non-common owners—that is, a mechanism where common ownership somehow induces management of a firm to take actions that reduce firm value but benefit the common owner because the actions increase the value of competing firms. Moreover, the most significant empirical evidence relates to mechanisms that target specific decisions of the firm (as opposed to operating “across the board,” say, through the compensation scheme) and active (that is, they involve affirmative actions by the common owner, rather than a mere failure to act).

Second, some mechanisms are likely either infeasible or ineffective. To be feasible, a CCO must have the power and ability to employ the mechanism. Yet institutional investors generally lack the capacity to generate, transmit, induce, and monitor targeted active strategies. To be effective, use of the mechanism must raise the value of companies held by the CCO net of any collateral value reductions caused by the mechanism. Yet most across-the-board strategies, such as weakening pay-for-performance compensation structures, result in a wholesale dilution of incentives to maximize firm value, whether or not doing so benefits competing firms.

Third, several mechanisms are not in the interest of institutional investors even if they increased that investor’s portfolio value. Although treated as “common owners” in the empirical literature, institutional investors such as Blackrock, Vanguard and Fidelity, are not the owners of the shares attributed to them. Rather, they merely exercise investment and voting power over shares owned by others. Increasing portfolio value benefits such institutions only if the additional profits that they obtain exceeds the costs from employing a mechanism. But such profits amount only to a small percentage of the increased portfolio value. Meanwhile, many mechanisms entail significant legal and reputational risk to CCOs, making it unlikely that institutional CCOs would benefit by employing them.

Our main conclusion is that, for most mechanisms, there is either no strong theoretical basis for believing that institutional CCOs could and would want to employ them or no significant evidence suggesting that they do employ them, or both. However, our judgment is not uniformly negative. In particular, a new mechanism that we call “selective omission” is consistent with both theory and the empirical evidence. A CCO engaged in selective omission presses for firm actions that increase both firm value and portfolio value, while remaining silent as to actions where the two conflict. In addition, some across-the-board mechanisms may be plausibly employed, though substantial empirical evidence for their use is lacking thus far.

Our analysis has several important implications. First, the empirical literature has paid too little attention to systematic differences in the incentives of different investor types. For example, institutions that mostly manage index funds must be distinguished from other CCOs in any serious analysis of anticompetitive effects. Index funds are, at first blush, the most plausible culprits because they tend to own similar stakes across multiple competitors and maintain stable holdings over time, which, as we show, facilitates the use of certain mechanisms. Institutions that mostly manage index funds, however, have the lowest incentives and the least capabilities to employ targeted mechanisms. Our analysis therefore suggests that index funds either play no significant role in generating anticompetitive effects or else systematically employ different mechanisms than other types of institutional investors.

Second, even to the extent that common concentrated ownership is associated with anticompetitive effects, the welfare effects of CCOs are ambiguous. If CCOs do induce the anticompetitive outcomes for which they have been blamed, they also can be expected to push actions, such as the elimination of redundant expenditures, that increase profits by making the firm more efficient. Moreover, where CCOs own some but not all firms in a market, the effects are subtle. Such CCOs have different incentives, which cause them to avoid and even counteract the harms that have been attributed to common ownership.

Third, our analysis indicates top priorities for further research. The empirical literature, as it has developed so far, raises concerns that deserve significant attention, but are neither sufficient to establish that CCOs engage in selective omission nor well designed to test certain other plausible casual mechanisms. We suggest studies to fill the gap and emphasize the importance of seeking direct evidence of the steps taken by CCOs, and the responsive steps taken by firms, that produce anticompetitive results.

Finally, our analysis shows that, depending upon the specific mechanism at work, wide-ranging reform proposals are likely to be ineffective and counterproductive. The most likely effects of these proposals, if adopted, are greater passivity by shareholders and fragmentation of institutional shareholdings in portfolio companies in all industries, not just in concentrated ones. The proposals would thus be ineffective if non-active mechanisms are responsible for anticompetitive results; and they would be counterproductive because they reduce shareholder power and incentives to induce portfolio companies to increase their value in the range of circumstances where doing so is not anticompetitive.

The complete paper is available for download here.

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