One of the hottest antitrust topics of late has been institutional investors’ “common ownership” of minority stakes in competing firms. Writing in the Harvard Law Review, Einer Elhauge proclaimed that “[a]n economic blockbuster has recently been exposed”—namely, “[a] small group of institutions has acquired large shareholdings in horizontal competitors throughout our economy, causing them to compete less vigorously with each other.” In the Antitrust Law Journal, Eric Posner, Fiona Scott Morton, and Glen Weyl contended that “the concentration of markets through large institutional investors is the major new antitrust challenge of our time.” Those same authors took to the pages of the New York Times to argue that “[t]he great, but mostly unknown, antitrust story of our time is the astonishing rise of the institutional investor … and the challenge that it poses to market competition.”
Not surprisingly, these scholars have gone beyond just identifying a potential problem; they have also advocated policy solutions. Elhauge has called for allowing government enforcers and private parties to use Section 7 of the Clayton Act, the provision primarily used to prevent anticompetitive mergers, to police institutional investors’ ownership of minority positions in competing firms. Posner et al., concerned “that private litigation or unguided public litigation could cause problems because of the interactive nature of institutional holdings on competition,” have proposed that federal antitrust enforcers adopt an enforcement policy that would encourage institutional investors either to avoid common ownership of firms in concentrated industries or to limit their influence over such firms by refraining from voting their shares.
In our recent paper, The Case for Doing Nothing About Common Ownership of Small Stakes in Competing Firms, we offer a cautionary critique of these proposals for increased antitrust enforcement. Our argument is two-fold. First, we argue that the theoretical arguments and empirical results motivating these proposals are inherently flawed and therefore do not provide a reliable justification for antitrust action. Second, we argue that the combined error and decision costs associated with either of the proposals likely outweigh whatever benefits, if any, may be achieved.
At issue is the growth in the incidence of common ownership across firms within various industries. In particular, institutional investors with broad portfolios frequently report owning small stakes in a number of firms within a given industry. Although small, these stakes may still represent large block holdings relative to other investors. Critics claim this intra-industry diversification causes managers to soften competition with their rivals rather than aggressively compete, since increasing own-share price at the expense of rivals’ share prices might reduce the portfolio values of intra-industry diversified shareholders,
Elhague and Posner, et al., draw their motivations for new antitrust enforcement from a handful of papers that purport to establish an empirical link between the degree of common ownership among competing firms and various measures of behavior that the authors’ claim reflect softened competitive behavior. The most cited of these studies is a paper by José Azar, Martin Schmalz and Isabel Tecu forthcoming in the Journal of Finance, which claims to identify a causal link between the degree of common ownership among airlines competing on a given route and the fares charged for flights on that route.
Azar, et al.’s airline paper uses a metric called a Modified Herfindahl–Hirschman Index (MHHI) to measure the degree of industry concentration, taking into account investors’ cross-ownership of stakes in competing firms. The original Herfindahl–Hirschman Index (HHI) has long been used as a measure of industry concentration, incorporated into the Department of Justice’s Horizontal Merger Guidelines in 1982. The HHI is calculated by squaring the market share of each firm in the industry and summing the resulting numbers, which results in a nicely bounded and intuitive measure of product market concentration.
The MHHI is more complicated. It includes both the HHI, measuring product market concentration, and an additional term called the MHHI∆, purportedly measuring the additional concentration due to common ownership. The MHHI∆ is intended to capture the relative concentration of cross-owning investors to all investors for each firm in the market as well as the combined market concentration of commonly owned firms. As the relative concentration of cross-owning investors increases, managers are assumed to be more likely to soften competition with that competitor. As commonly owned firms control more of the market, managers’ ability to tacitly collude and increase joint profits is assumed to be higher.
Azar, et al. calculate HHI and MHHI∆ for every U.S. airline route (assumed to be a product market) for each quarter from 2001 to 2014. They then regress ticket prices for each route against the HHI and the MHHI∆ for that route, controlling for a number of other potential factors. They find that airfare prices are 3 percent to 7 percent higher due to common ownership. Other papers using the same or similar measures of common ownership concentration have likewise identified positive correlations between MHHI∆ and their respective measures of anti-competitive behavior. This evidence is the “economic blockbuster” giving rise to Elhauge’s and Posner, et al.’s calls for increased antitrust efforts.
We argue that both the theoretical argument underlying the empirical research and the empirical research itself suffer from serious flaws. On the theoretical side, we have two concerns. First, there is a tremendous leap of faith (if not logic) in the idea that corporate executives would forgo their own self-interest and the interests of the vast majority of shareholders and soften competition for benefit of a small number of small stakeholders that are intra-industry diversified. Not only do most executives receive compensation based on own-stock performance, the market for managerial talent rewards managers that demonstrate an ability to best their industry rivals. Moreover, managers and corporate boards have legal fiduciary responsibilities to all shareholders, responsibilities that non-diversified shareholders have incentive to enforce.
Second, even if managers were so inclined, it clearly is not the case that softening competition would necessarily be desirable for institutional investors that are both intra- and inter-industry diversified, since supra-competitive pricing to increase profits in one industry would decrease profits in related industries that may also be in the investors’ portfolios. If in fact managers are motivated to maximize the value of their shareholders’ total portfolios, inter-industry diversification interests would likely more than offset any competition-softening incentive driven by intra-industry diversification.
When confronted with these theoretical problems, proponents of more vigorous antitrust efforts point to the empirical evidence as a trump card. However, the empirical evidence itself is far from conclusive. First, the data on institutional investors’ holdings are taken from Section 13(f) filings, which report aggregate holdings across all the institutional investor’s funds. Using these data masks the actual incentives of institutional investors with respect to investments in any individual company or industry, since the returns to individual funds may depend on just one or a few, rather than all, of the industry stocks in the aggregate portfolio.
More generally, institutional investors’ incentives are driven by the competitiveness of their retail funds vis-à-vis their competitors and by the profit margin each fund generates. On the former point, increased industry profit that benefits all institutional investors’ portfolios does not provide any institutional investor a competitive advantage. On the latter, holdings in some funds create more value for the institutional investor than holdings in other funds, so the institutions would prefer that stocks in their more profitable funds out-perform their peers.
Second, the construction of MHHI∆ suffers from serious endogeneity concerns, since it is determined, in part, by both market shares and the number of firms participating in a market. Factors that influence market shares may also influence market prices apart from any common ownership effect. For instance, seasonal demand fluctuations may lead to changes in market share and higher prices. Likewise, because the number of firms in the market increases the potential number of cross-ownership couplings in the MHHI∆ calculation, increased market demand that induces entry will tend to increase MHHI∆ at the same time prices are rising.
In the end, the empirical evidence of competition-softening from common ownership may warrant further research, but it is not the trump card proponents of common ownership restrictions proclaim it to be.
Even if common ownership by institutional investors did cause some degree of competition-softening in oligopolistic industries, the proposed solutions would impose administrative and error costs that would likely dwarf any competitive harms resulting from softened competition. Both Elhauge’s and Posner, et al.’s proposals entail high administrative costs on business planners, adjudicators, and regulators. Business planners would have to monitor perpetually for changes in MHHI and MHHI∆ which may result from factors beyond institutional investors’ control (e.g., the market shares of competing firms, changes in shareholdings of other investors that may or may not be intra-industry diversified, etc.). Adjudicators would have to weigh complex evidence on relevant market definitions and the potential for adverse competitive effects. Regulators, particularly in Posner et al.’s approach, would regularly have to define all the potential oligopolistic markets in the economy to provide guidance for institutional investors’ investment decisions.
Even greater than the proposed solutions’ administrative costs are the likely welfare losses that would stem from wrongly deterring welfare-enhancing arrangements. Under either solution, institutional investors would be required, or at least encouraged, either not to hold shares in more than one firm in any industry or to maintain strictly passive ownership. Because of the aggregated holdings issue, restricted holdings would mean Vanguard, for instance, could hold shares of only one airline in any and all of its retail funds, thereby eliminating a broad range of potential value-creating investment opportunities for retail investors. Similarly, strictly passive ownership would eliminate the ability of institutional investors to provide the sort of accountability that reduces agency costs and benefits all shareholders.
We conclude that proponents of antitrust intervention to police common ownership simply have not made their case. Their theory of harm is implausible. The empirical evidence supporting it is scant and methodologically suspect. And the policy solutions they offer entail extraordinary costs both in implementation and in their consequences for the functioning of capital markets. Courts and antitrust enforcers should reject their calls for expanded antitrust intervention.
This post comes to us from professors Thomas A. Lambert at the University of Missouri School of Law and Michael Sykuta at the University of Missouri. It is based on their recent paper, “The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms,” available here.