How Horizontal Shareholding Harms Our Economy—and Why Antitrust Law Can Fix It - PowerPoint Presentation

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How Horizontal Shareholding Harms Our Economy—and Why Antitrust Law Can Fix It

Einer Elhauge

Petrie Professor of Law

Harvard Law School

Horizontal Shareholding

When

the leading shareholders of horizontal competitors overlap

.

Decreases incentives to compete: equivalent

to increased marginal cost because taking sales from rival costs shareholders profits in other firms.

Industry studies confirm horizontal

shareholding raises airline & banking prices

significantly

Results replicated unless redone using invalid methods:

Use “proxies” for HS that are negatively correlated with HS

Assume longer flights have lower costs

Ignore fund family combinations of stock

Set shared voting rights equal to

zero

Correcting for valid critiques increased price effects

Economic Proofs

If

managers

maximize (1) expected vote share

or

(2) probability of re-election

,

they will

maximize

weighted

average of

their shareholders

’ profits from

all

their

stockholdings.

If (1), weight by voting shares, so increased horizontal

shareholding proportionally increase

prices

If (2), weight by

odds

particular shareholder’s

vote will be pivotal,

so extra

weight to the largest

shareholders

Proof accounts for shareholder

heterogeneity & provides theoretical basis for MHHI/GHHI measures

Communication unnecessary, but can increase weight of communicating shareholders

Effect on Executive Compensation

Puzzle: Efficient for incentive-based compensation to be based only on firm performance, but much instead reflects industry performance.

Economic proof: with horizontal shareholding, maximize shareholder interests by increasing weight of industry performance. (With full horizontal shareholding, equal weight on rival and firm performance.)

Empirical evidence: markets with higher horizontal shareholding do just that. 99% statistical confidence.

Requires no coordination or communication.

Provides direct incentive to lessen competition.

Effects on Investment & Inequality

From 1999 to 2014, probability

that two

large competing

firms

have

a

large horizontal

shareholder

increased

from 16%

to 90%.

Over same period

gap between corporate investment and profits increased by the largest extent since World War II.

Greatest decline in labor share of income since World War II.

Regression analysis: investment-profit gap driven by

level of horizontal shareholding in concentrated industries

within those industries, by the firms with high horizontal shareholding levels

.

Suggests gap not driven by automation, declining productivity or innovation, tax or regulatory policies, etc.

2 New Industry Studies in Pharma

Increased

horizontal shareholding between

incumbent branded drug & entering

generic

increases

By 5% the odds of a reverse payment settlement

that

delays entry

The size of entry delay

Increased

common ownership between drug manufacturers and potential generic entrants reduces the odds of generic entry by

9-13%

Anticompetitive Effects Not Prevented by

Fiduciary duties to

nonhorizontal

shareholders

Models assume do consider

nonhorizontal

interests

Business judgment rule

Lack of net injury to

nonhorizontal

shareholders

Argument would apply equally to mergers

Vertical shareholding

Horizontal shareholders not equally invested vertically: S&P 500 firms include all 4 major airlines but pay 5% of airfares

When are equally invested vertically, horizontal shareholding at multiple levels worsens problem by creating successive markups

Can have its own adverse vertical effects

Index fund incentives

(next)

Do Index Funds

Lack Incentives?

BCH:

Implausible b/c

increased corporate performance cannot help compete for investment flow with other index funds, so exert

effort only if

, but

1. The

Incremental Costs of Facilitating Lessened Competition Are Generally Zero or Negative.

BCH admit

C

= 0 for decisions about how to vote or positions to take when talking to managers.

Have

legal duty to engage in informed voting & it costs the same to vote either way

.C and IC probably negative for shareholder influence on competitive behavior because Competing vigorously is hard work for managersManagers benefit from executive compensation that rewards them for industry performance

Do Index Funds

Lack Incentives?

2. Even When Costs Are Positive, They Are Small Relative to the Anticompetitive Gains.

can spread

C

across many corporate investments & long time horizon

Average

index fund fee is 0.12%

pre year, so present value of increased corporate valuation makes

𝛼

more like 1.2%

massive: back of

envelope

60

% or more of stock in markets with high HHI and ΔMHHI anticompetitive effects in such markets make corporate profit margins double or moreBlackRock manages $3.3 trillion in stockSo 𝛼 = (1.2%)($3.3 trillion)(60%)(50%) = $12 billion

Do Index Funds

Lack Incentives?

3. Index Funds Do Have Incentives to Compete with Other Funds for Investment

Flow

Compete with active funds and personal investments for investments – flow in 2015 was $575 billion

Given different holdings, increased performance of index funds can increase returns relative to active funds

Even if same raw return, means higher net performance for index funds given lower fees (0.12% to 0.79%)

Collective action problem minimized because index fund market concentrated:

BlackRock

39

%, Vanguard 33%,

State

Street 23

%

If increased performance affects half the total flow & flow tracks index market shares, that means increased present value of fees of

$13.4 billion at BlackRock, $11.4 billion at Vanguard, and $7.9 billion at State Street

Do Index Funds

Lack Incentives?

4

.

Index Funds Are Not the Main Horizontal Shareholders and Are Voted by Fund Families That Also Have Active Funds.

Index

funds accounted for only 29% of all institutional investor

funds

Index fund families have hundreds of billions in active funds

Given higher fees on active funds, BlackRock earns about as much in fees on active funds as passive ones

Active

funds do not lose any of their incentives to exert effort to increase corporate value by being in the same fund family as index

funds

Just increases incentives for effort because fund family has additional voting power by voting the index fund shares as well

Do Index Funds

Lack Incentives?

5. What

Matters Is Relative Shareholder Influence, Not Whether Shareholder Effort Is Fully

Optimal

BCH assume proper benchmark is

sole 100%

owner who exerts effort whenever

Not the right baseline for optimal effort

Total cost of $1 million to increase value by $1 million, no welfare gain

Want to maximize

difference

between value enhancement & total cost

Effort only if marginal increase in value > marginal increase in costAt initial effort levels, index funds have ample incentives to exrt effortFor anticompetitive effects, what matters is influence of index funds and other horizontal shareholders relative to other shareholders. High becauseIndex funds vote far more oftenCannot exitLarger stockholding gives higher odds of affecting corporate behaviorHave fiduciary duties to vote knowledgeablyCan spread costs of effort on common governance issues (like executive compensation methods) across many more corporations 

Do Index Funds

Lack Incentives?

6. Empirical Evidence Shows That Index Fund Families Do Exert Effort and Influence.

63

% of institutional investors talk with corporate managers. One admitted high on agenda was urging price increases over competing for market share.

53

% tried to influence managers by voting against them.

BlackRock

: 1500 private engagements with firms & CEO says “we are … imposing more of what we think is correct” and “We can tell a company to fire 5,000 employees tomorrow.”

Index fund ownership has

statistically significant correlation

with

anti-management

votes,share

of directors who are independent,

poison pill removals, reduced dual class shareholding, and increased rate of return. Horizontal shareholding by institutional investors affects executive comp, corporate investment & product prices

Clayton Act §7 Remedy

Stock

acquisitions likely to have anticompetitive effects violate Clayton Act §

7, even if no control or influence.

Passive

investor

“exception” no obstacle because applies

only if

solely for investment

=

don’t vote or otherwise influence

and

does not actually have

likely anticompetitive effects

Should investigate if HHI > 2500 & ΔMHHI > 200 & condemn if likely anticompetitive effects are found

Sherman Act § 1 Remedy

Any

“contract, combination in the form of trust or otherwise, or conspiracy”

that

imposes a net restraint on

competition is illegal.

Horizontal shareholding involves formal

contracts

whose voting & financial rights create the anticompetitive effects.

Anti

trust

law aimed to prohibit

trusts

that

were horizontal shareholders. So also a “combination”.Effect of multiple contracts aggregated: e.g., exclusive dealing and vertical price-fixingGiven possible efficiencies, rule of reason, so need to show anticompetitive effects.

Extension to EU Merger Law

EU merger control regulation more narrow than Clayton Act because need control

But could cover stock acquisitions that potentially give horizontal shareholders collective decisive influence

Would require changing enforcement practice to not require contractual or direct links among shareholders. Similar to

G

encor

change that extended old merger regulation to mergers creating collective dominance.

But would still fail to address full problem since collective decisive influence not necessary for anticompetitive effects

Extension to TFEU 101

Prohibits

“agreements” or “concerted practices” between undertakings that have the effect of restricting competition.

At least as broad as Sherman Act

Philip Morris

held applies to minority stock acquisitions if they have “effect of influencing the competitive

behaviour

”, which is what the effect of horizontal shareholding is.

“

Concerted practices” extends beyond agreements to cover any “indirect contact” that has the effect of influencing conduct of competitor.

Suiker

Unie

. Horizontal shareholding is such an indirect contact.

Extension to TFEU 102

Bans abusing collective dominance, including through excessive pricing.

Good reasons not to enforce excessive pricing provision against

Monopoly pricing, because such pricing is a desirable reward for investment

Oligopoly pricing, because it is unavoidable

But horizontal shareholding that raises prices

Does not reflect desirable reward for investment

Is not unavoidable

Does create a collective dominance based on contractual & structural links that results in excessive pricing

This legal claim eliminates need to show ongoing agreement

This interpretation also solves puzzle of how to give some sensible meaning to the excessive pricing provision.