Debt, Control, and Collusion

• Citation: Vol. 71 No. 4
• Publication year: 2022

Debt, Control, and Collusion

D. Daniel Sokol

DEBT, CONTROL, AND COLLUSION

D. Daniel Sokol^*

Abstract

Partial ownership of stock in multiple competing firms is an important topic in both corporate and antitrust law. Until now, the discussion has focused on ownership. This Article shifts the discussion from a focus on common ownership to a focus on common control. No prior work has addressed the role of debt-related corporate control in corporate governance and competition, but debt-control-based governance is a critical part of the corporate landscape. Further, various creditors can exert control over more than one company in the same industry without any ownership. These insights have been addressed in the corporate finance and bankruptcy law literatures, but they have not yet penetrated antitrust debates or policy. Applying such insights, this Article suggests that a fundamental change in antitrust policy is necessary to police against debt-control-based collusion.

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Table of Contents

Introduction.............................................................................................697

I. Antitrust Economics and Common Ownership........................699

A. Antitrust and Common Ownership Issues................................. 699
B. Antitrust Economics and Debt.................................................. 705
C. Antitrust Implications ............................................................... 707

II. Debt and Control.........................................................................708

A. Overview of Debt and Control Issues....................................... 708
B. Hedge Funds, Private Equity, and Distressed Debt Funds ...... 714
C. Fiduciary Duties ....................................................................... 716

III. Antitrust and Debt.......................................................................718

A. Antitrust Tacit Collusion .......................................................... 718

1. Multimarket Contact........................................................... 721
2. Signaling Through Disclosure............................................ 722
3. Signaling Through Bankruptcy Filings .............................. 724
4. Learning by Doing.............................................................. 725
5. Executive Compensation .................................................... 726

B. The Particular Roles of Hedge Funds, Private Equity Firms, and Distressed Debt Lenders in Collusion ............................... 727

IV. Possible Solutions........................................................................730

A. Modification of Antitrust Merger Law...................................... 730
B. Use of Corporate Law to Help Explain Control for Antitrust Purposes ................................................................................... 734
C. Other Legal Systems that Offer Some Guidance on a More Robust Inclusion of Debt-Based Control.................................. 735

1. Japan .................................................................................. 735
2. European Commission ........................................................ 736
3. United Kingdom ................................................................. 736

Conclusion.................................................................................................737

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Introduction

A recent wave of literature claims that common ownership of portfolio firms across an industry by institutional investors may lead to anti-competitive behavior.¹ Common ownership within the same industry by mutual funds may create incentives for mutual funds to maximize the returns of their portfolio through collusion rather than maximize the value of any particular company within its portfolio.² Such behavior, if it exists, may violate antitrust law and harm consumers.³

Before proceeding with the organization of this Article, we begin with an overview of basic terms and concepts. At a basic level, there is equity and debt. Equity has various economic, managerial, and exit rights because of ownership. Debt is a different finance tool that provides capital without any of the upsides of ownership but for which the creditors receive payments made of principal and interest.

Normally, an owner of a single firm wants to maximize the profit of that one firm. This assumption may be relaxed when the same owner has a portfolio of

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multiple firms in the same industry.⁴ In this common ownership scenario, the owner of a portfolio of multiple firms may want to maximize the economic value of the entire portfolio of firms rather than any single firm, consequentially reducing competition across these firms.⁵ Specifically, Owner A would normally maximize the return of Firm 1. However, when Owner A has a portfolio that includes Firms 1, 2, 3, and 4, and all four firms are in the same industry (such as the airline or fast-food industry), Owner A would prefer that the portfolio of the four forms not compete as hard, so as to maximize the joint return of all four firms.

The same incentives for maximizing the return of a portfolio of firms may also exist for certain types of debt, especially when equity investment is riskier—such as when a firm is close to, or in, bankruptcy. In that scenario, debtholders may have economic or legal control (through contractual terms) of the managerial decision-making of their portfolio of companies.⁶

This Article explores these types of tensions in greater detail. It does so by shifting the debate from a focus on common ownership to a focus on common control. No prior work has addressed the role of debt-related corporate control in corporate governance and competition, yet debt-control-based governance is a critical part of the corporate landscape.⁷ Further, various creditors can exert control over more than one company in the same industry without any ownership. These insights, though found in the corporate finance and bankruptcy law literatures, have not penetrated antitrust scholarly debates or policy. Applying such insights, this Article suggests that a fundamental change in antitrust policy is necessary to police debt-control-based collusion.

The change is necessary based on a gap in the statutory structure of antitrust merger law—a gap that exempts pure debt transactions from antitrust scrutiny.⁸ This gap also exists in antitrust policy and scholarship. For a field focused on the creation of legal rules that reflect an understanding of economic effects, it is surprising that antitrust law and economics have missed a fundamental issue that harms consumers. Even odder is the fact that antitrust law's current approach to debt under the Hart-Scott Rodino Act focuses on form rather than substance (e.g., antitrust agencies do not need to be notified about pure debt transactions

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regardless of the economic consequences of debt-based control because there is no change in ownership),⁹ despite the fact that, in other areas, antitrust law typically favors substance.¹⁰

In Part I, this Article provides an overview of the antitrust common ownership debate. Parts II and III identify the incentives for both management and creditor engagement in debt-control-based collusion and the mechanism by which such anti-competitive conduct can occur. Next, in Part IV, this Article argues that the appropriate antitrust test for mergers should be about a change of control rather than a change of ownership, so that transactions that can change a firm's fundamental economic power of governance can be reviewed by antitrust authorities. This new approach represents a paradigm shift reflecting the insights from corporate finance and corporate governance that have not yet impacted antitrust thinking. Finally, also in Part IV, this Article posits opportunities for policy reform, suggesting the introduction of a voluntary notification scheme, and for further research on debt-based collusion, focusing on the use of machine learning. It identifies and explains the potential anti-competitive effects of partial control and suggests an enforcement approach that is administrable within the framework of the existing antitrust theories of harm.

I. Antitrust Economics and Common Ownership

This Part identifies the issues involved in antitrust economics and common ownership. First, it identifies the theory of competitive harm in common ownership in law and economics. Second, it illustrates the current gaps in scholarship and policy.

A. Antitrust and Common Ownership Issues

Common ownership by one or more owners across a portfolio of firms in a given industry (as facilitated by, for example, hedge funds, mutual funds, and private equity funds) may bring about anti-competitive effects by reducing the competition across firms within the commonly owned portfolio.¹¹ Normally,

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firms compete with each other, with a gain by one firm detracting from the market share of its competitors.¹² In the case of common ownership, an institutional investor that has stakes in Firms A, B, and C enjoys a greater total profit from their entire portfolio if there is coordination across the firms and, hence, less competition.¹³

A common owner across firms in the same industry will want to maximize their entire portfolio of investments rather than maximize their investment in one particular firm in its portfolio.¹⁴ This means that a common owner will find a way to influence the profitability and conduct of its portfolio company rivals when they make strategic decisions in each of their portfolio firms.¹⁵ This behavior is collusive and may harm consumers.

The existence of an antitrust common ownership problem was first recognized in the 1980s.¹⁶ Theoretical literature continued to engage in this debate intermittently.¹⁷ However, a series of empirical finance and law review

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articles in recent years have drawn attention anew to the issues of common ownership and...