Calm Down about Common Ownership: The evidence of anticompetitive harm from institutional investing is weak, and the proposed policy solutions would be more harmful than the supposed problem.

AuthorLambert, Thomas A.
PositionANTITRUST

Prominent antitrust scholars have recently sounded alarm bells about large institutional investors' "common ownership" of competing businesses. Writing in the Harvard Law Review, Harvard Law School's Einer Elhauge proclaimed that "an 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 of the University of Chicago and Fiona Scott Morton and Glen Weyl of Yale University 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 "the 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 offered solutions to the alleged problem. Elhauge has called for using the Clayton Act's Section 7, which precludes anticompetitive mergers, to police common ownership of minority stakes in competing firms. Posner et al. have proposed a government enforcement policy that would encourage institutional investors either to avoid holding stock of multiple firms in concentrated industries or to limit their influence over such firms by not voting their shares.

These scholars are getting ahead of themselves. There are serious difficulties with both the claim that small-stakes common ownership poses a significant competitive problem and the solutions the scholars have offered for that purported problem. We show below that the problem's existence has not been adequately established and that, even if it does exist, the proposed policy cures would be worse than the disease. First, though, we describe the alleged problem.

THE PURPORTED PROBLEM

Given the recent explosion in index investing, institutional investors that sponsor index funds--Vanguard, BlackRock, Fidelity, etc.--are now among the largest shareholders of most publicly traded companies. They frequently hold significant stakes in all the firms in an industry. Proponents of restrictions on common ownership theorize that this pattern of institutional investment could reduce market competition and they point to empirical evidence purporting to show that such theoretical harm is, in fact, occurring.

Theory of harm / An investor in a single firm within a market--say, American Airlines--would prefer that the company try to win business from its rivals. By contrast, an investor holding stakes in all the firms in a market--American, Delta, Southwest, and United, if those were the only airlines servicing a particular route--would not want the firms to compete vigorously. After all, any gains to one competitor would come at the expense of other firms in the investor's portfolio.

An investor that is "intra-industry diversified" in this fashion would prefer maximization of industry profits, whereas a single-firm investor would prefer that its company maximize own-firm (i.e., just its own) profits. Corporate managers typically maximize own-firm profits by growing market share, and they do that by expanding output, enhancing quality, and discounting prices. Industry profits, by contrast, are maximized when corporate managers collectively act like a monopolist by reducing output, expenditures on product improvements, and discounts from the levels that would attain in vigorous competition. Because institutional investors tend to be intra-industry diversified, they prefer maximization of industry profits and therefore want their portfolio companies to pull their competitive punches.

But why would corporate managers defer to the interests of institutional investors when most of their companies' shareholders are not intra-industry diversified? The theory is that institutional investors are better positioned to influence management decision-making. Relative to individual shareholders, institutional investors possess more extensive monitoring resources and greater expertise on matters of business strategy and firm policy. They also hold larger stakes in the corporations in which they are invested, and they therefore have greater incentive to become informed before voting their shares in director elections and on shareholder proposals, executive compensation packages ("say-on-pay"), etc. What's more, the votes of institutional investors often attract media attention, amplifying such investors' power over management. Given their greater clout, institutional investors are in a better position to engage corporate managers, and anecdotal evidence suggests they regularly do so. For all these reasons, corporate managers often honor the preferences of institutional investors over those of individual, uncoordinated stockholders, even when the latter collectively own a greater proportion of company stock.

Putting all this together generates the two main premises of the theoretical argument that common ownership by institutional investors softens competition in concentrated industries. Those premises are:

* Intra-industry diversified institutional investors have an interest in maximizing industry profits and would prefer that corporate managers not engage in business-usurping competition that would enhance own-firm profits but reduce overall profits within the industry.

* Institutional investors have sufficient influence over corporate managers to induce them to refrain from own-firm profit maximization in favor of greater industry profits.

Both of these premises ultimately prove to be flawed. However, before we explain those flaws, we first present the evidence often cited in support of the claim that institutional investing harms competition.

Evidence of harm/Two recent studies--one involving the U.S. airline industry, the other involving commercial banks--purport to demonstrate that institutional investors' common ownership of competing firms has reduced competition and injured consumers in concentrated industries.

In "Anti-Competitive Effects of Common Ownership" (the airline study), co-authors Jose Azar, Martin Schmalz, and Isabel Tecu tested whether institutional investors' common ownership of interests in domestic airlines raised airfares higher than they otherwise would be. To assess common ownership and the degree to which it changed over time, the authors employed a measurement known as "MHHI delta" (MHHI[DELTA]).

MHHI[DELTA] is a component of the "modified Herfindahl-Hirschman Index" (MHHI), which, as the name suggests, is a modification of the Herfindahl-Hirschman Index (HHI), a well-known measure used in evaluating the legality of business mergers. HHI, which ranges from near zero to 10,000 and is calculated by summing the squares of the market shares of the firms competing in a market, assesses the degree to which a market is concentrated and thus susceptible to collusion or oligopolistic coordination. MHHI endeavors to account for both market concentration (HHI) and the reduced competition incentives occasioned by common ownership of the firms within a market. MHHI[DELTA] is the part of MHHI that accounts for common ownership incentives, so MHHI = HHI + MHHI[DELTA].

Calculating MHHI[DELTA] for a particular market is a bit complicated. (For an explanation, see Appendix A of our working paper listed in the Readings.) For present purposes, it will suffice to understand what MHHI[DELTA] purports to measure and which variables determine its magnitude. MHHI[DELTA] aims to assess the degree to which the managers of firms within an industry, on the assumption that they seek to maximize their shareholders' portfolio returns, would cause their firms to avoid vigorous competition in an effort to maximize industry rather than own-firm profits. The primary variables that determine MHHI[DELTA] are:

* the degree of control intra-industry diversified investors exercise over the...

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