Given their importance to corporate governance and often impressive credentials and experience, , many directors are “busy,” meaning they hold concurrent board appointments across multiple firms. These so-called “interlocks” between companies are a growing phenomenon, but not a new one. Interlocking directorates have been prevalent among the largest U.S. firms for over a century, with nearly 85 percent of S&P 1500 firms sharing at least one director with another S&P 1500 firm in the early 2010s.

However, there is particular concern when directors serve on boards of competing firms, forming “horizontal” interlocks. In a recent paper, I study the effect of such interlocks on firm performance, governance, and innovation.

In 1912, the House of Representative’s Pujo Committee highlighted widespread collusion and concentration, leading to the Clayton Act of 1914, which outlawed the interlocking of rival firms. Section 8 of the Clayton Act generally prohibits “horizontal directors” by banning any person from serving as a director or officer of any two corporations that are engaged in commerce and are competitors by virtue of their business and location of operation. While the Act was followed by a wave of directors resigning interlocking posts, it was soon apparent that the regulation had failed to achieve the desired result. A report by the National Resources Committee from the 1930s found pervasive board interlocks among the largest firms: 225 of the 250 largest corporations were interlocked with others. A 1951 Federal Trade Commission (FTC) report called for an amendment to the Clayton Act that would crack down on the practice.

Overall, there have been relatively few enforcement cases filed under Section 8 of the Clayton Act. Between 1899 and 2022, the Department of Justice (DOJ) had filed only 11 cases under the violation of “Interlocking Directorates and Officers” out of 2,368 antitrust cases in total, which amounts to less than 0.5 percent. The FTC attributes this seeming under-enforcement to the fact that the most frequent remedy is director resignation, as Section 8 grants a one-year grace period for directors to resign.[1]

Securing director resignations proved effective as a deterrent at first but had no long-term impact. For example, Eric Schmidt and Arthur Levinson both held concurrent seats on the boards of Apple and Google when the two companies were developing competing mobile operating systems. A 2009 FTC investigation of collusion in the labor market by several tech companies suggested that common directors were instrumental in coordinating hiring policies of engineers across firms.

However, this view of interlocks may be too simplistic. In my paper, I suggest and explore a potential transmission mechanism, whereby horizontal directors may facilitate coordination and benefit firms by decreasing strategic uncertainty about a competitor’s actions. A common director has both the ability and incentive to temper competition between rivals. He holds information and influence over the biggest and most important strategic decisions each firm makes, while having his compensation tied to their individual performance.

Using data on individual board appointments, I examine existing interlocks and focus on examples of directors leaving a company for external reasons, such as death or after a merger or acquisition in which the entire board is dismissed, to estimate the impact of horizontal interlocks on firm performance. Across all public U.S. firms, the loss of a horizontal interlock, and not a director, reduces returns on assets by roughly 3 percentage points, on average, which is equivalent to about one quarter of earnings. This effect on performance occurs immediately in the following year and does not attenuate in the years to follow.

Firms may try to compensate for the loss by seeking new interlocks. After a directors lose a seat on a rival board, the average firm appoints new directors, who tend to already sit on other boards, creating new interlocks in general and horizontal ones in particular. Comparing across directors within the same board, directors are more likely to remain in their seats as long as they interlock with a rival, but less likely after severance.

Using data on patents, I find that horizontal interlocks may actually facilitate innovation.  Consider a board member of a pharmaceutical firm who recommends a course of action for the firm while  knowing that a rival is about to reach a breakthrough on a valuable project. With compensation tied to the performance of each firm, this director could benefit from steering the firm away from the direction of that particular project, which is unlikely to be a winner. Indeed, my research shows that rival firms converge in their technology space after the loss of a horizontal interlock. This likely causes them to compete over similar patents and reduces the overall patent output of each. Over time, these firms tend to produce fewer patents in the particular technological area of the no-longer-interlocked competitor.

Finally, I show that these interlocks play a key role when they exist among competitors who are also technological peers. In contrast, patent output is unaffected after losing an interlock with a non-peer rival or with a non-rival peer. This makes sense, as a common director of non-peer rivals would not be able to provide useful technological guidance (think about manufacturers of pens and pencils). Similarly, non-rival peers have no concern with overt communication and cooperation, so a shared director does not offer a unique channel of information.

My paper highlights non-trivial potential benefits of horizontal interlocks. It is possible in principle that some coordination among competitors would be welfare-enhancing in certain settings of high synergy or redundancy, like R&D. At the same time, my findings cannot be generalized to all settings, and there is no evidence that such benefits  arise in, say, the market for retail grocery, where coordination could allow rivals to segment geographical or product markets and lower the threat of entry.

Over the last few years, we have witnessed a renaissance in enforcement against interlocks. A 2022 press release by the DOJ stressed that “Section 8 is an important, but underenforced, part of our antitrust laws. Congress made interlocking directorates a per se violation of the antitrust laws for good reason. Competitors sharing officers or directors further concentrates power and creates the opportunity to exchange competitively sensitive information and facilitate coordination – all to the detriment of the economy and the American public.”[2] With renewed interest and attention from regulators and practitioners, this is an opportune time to revisit and study these open questions of how corporate governance relates to matters of competition and innovation.

ENDNOTES

[1]  https://www.ftc.gov/enforcement/competition-matters/2017/01/have-plan-comply-bar-horizontal-interlocks

[2]  https://www.justice.gov/opa/pr/directors-resign-boards-five-companies-response-justice-department-concerns-about-potentially

This post comes to us from Roma Poberejsky at Northwestern University’s Kellogg School of Management and Cornerstone Research. It is based on his recent paper, “Interlocking Directorates, Competition, and Innovation,” available here. The views expressed here are his alone and do not necessarily represent the views of Cornerstone Research.