Horizontal shareholding occurs when a number of equity funds own shares of competitors operating in a concentrated product market. For example, the four largest mutual fund companies might be the four largest shareholders of all the major U.S. airlines. (1) A growing body of empirical literature concludes that under these conditions, market output is lower and prices are higher than they would otherwise be. (2) Due to the twin trends of increases in the mutual fund industry and the rise of concentration in the U.S. economy, the impact of lessening competition due to common ownership by mutual funds has a potentially adverse effect on consumer welfare. We argue here that the "effects" test articulated for mergers in Section 7 of the Clayton Act permits challenges to such mergers, whether or not the precise mechanism by which such mergers elevate product prices in a particular case is precisely known. (3)
We adopt two assumptions throughout this Feature: first, the firms in a concentrated product or service market are not fixing prices in a way that would subject them to liability under Section 1 of the Sherman Act; second, the managers of the funds that acquire interests in their shares are not agreeing with each other about how to purchase or vote the shares or otherwise influence the behavior of these firms. If either of these two horizontal agreements existed, it would be independently actionable under Section 1 of the Sherman Act. Rather, this Feature considers the extent to which antitrust can be brought to bear against horizontal shareholding without proof of one of those two forms of illegal agreement.
Part I discusses the development of large-scale mutual fund ownership and evaluates the resulting threats to competition. Part II examines the antitrust legal theory justifying enforcement, including the Clayton Act's plain language "effects" test. Part III explains why an "efficiency defense" is relatively unimportant to such mergers. Then Part IV considers the Clayton Act exemption for stock acquisitions "solely for investment." Finally, Part V considers the use of post-acquisition evidence. We conclude that to the extent the empirical evidence warrants the conclusion that large scale horizontal acquisitions threaten reduced product output and higher prices, the existing tools of antitrust merger enforcement are sufficient to support challenges to those acquisitions.
TRENDS: INCREASING MUTUAL FUND OWNERSHIP AND INCREASING FUND SCALE
The Increasing Competitive Significance of Mutual Fund Ownership
In the United States, the diversified mutual fund industry arose in the 1970s. (4) This model of saving and investing greatly benefits consumers by allowing them to invest small amounts in a huge range of assets at low cost. The development of the index fund also freed consumers from paying high fees for professional stock-picking and instead allows them to invest in the whole market at low cost. (5) Economies of scale in running a fund allow large funds to offer lower fees and greater diversification, two attributes desired by consumers. Funds like Vanguard and Fidelity were early and successful movers in the space and today have large market shares, along with BlackRock and State Street. (6)
By "institutional investors," we refer to asset managers, companies that manage mutual funds, sovereign wealth funds, and any other entities that manage stock market investing on behalf of final owners. Institutional investors today own roughly 70% of the U.S. stock market. (7) While the large mutual fund companies listed above hold in the range of 4-6% of the U.S. stock market each, thousands of smaller asset management organizations together hold the remaining approximately 50%. (8)
Competition economists initially failed to recognize the impact of institutional investors on competition, perhaps because the funds held small shares in competitors in absolute terms. (9) The last two decades have seen a dramatic change:
[W]hen combined, BlackRock, Vanguard, and State Street constitute the single largest shareholder in at least 40 percent of all listed companies in the United States.... When restricted to the pivotal S&P 500 stock index, the Big Three combined constitute the largest owner in 438 of the 500 most important American corporations, or roughly in 88 percent of all member firms. (10) Just seventeen years ago, BlackRock, Vanguard, and State Street combined were the largest shareholder in only 25% of the S&P 500. (11) Similarly, fewer than 10% of U.S. public firms had institutional investors in common with product market competitors in 1980, while that percentage rose to 60% by 2014. (12) Thus, the widespread occurrence of common ownership of firms that compete in the product market, or horizontal shareholding, in this form is relatively new and has not yet attracted policy or enforcement action from the agencies.
Competitive Effects of Horizontal Shareholding
For a competition problem to arise from large shareholders holding product market competitors, those owners must have the incentive and ability to soften the intensity of competition, which harms consumers when pursued in an output market. (13) We begin by showing ability. Large shareholders engage in corporate governance, which may provide the ability to soften competition. (14) Indeed, many activists have been encouraging better and increasing corporate governance over the last few decades, and we see evidence of large mutual funds engaging in oversight of their portfolio companies. (15) Fund representatives meet with management, give opinions, vote on compensation, and so forth. Fund managers typically accumulate all the votes they control from all their funds and fund families and vote them as one block in order to increase their influence. (16) Certainly the funds themselves make statements indicating their belief that they can influence decisions of the firms they hold. For example:
We engaged with roughly 1500 companies around the world in 2012. When we engage successfully and companies adjust their approach, most observers are never aware of that engagement.... We typically only vote against management when direct engagement has failed... engagement encompasses a range of activities from brief conversations to a series of one-on-one meetings with companies. (17) And along the same lines:
[B]y its nature, voting [is]... a rather blunt instrument. [E]ngagement with directors and management of the companies in which we invest provides for a level of nuance and precision that voting, in and of itself, lacks. So while voting is visible, it tells only part of the story.... We have found through hundreds of direct discussions every year that we are frequently able to accomplish as much--or more--through dialogue as we are through voting. (18) The ability to soften competition must be paired with the incentive to do so if outcomes are to change. In standard economic models of competition, softer product market competition leads to higher prices and higher profits for the product market firm. (19) A firm earning higher profits experiences an increase in its stock price, and any mutual fund holding that stock experiences higher returns as a consequence. Funds benefit from higher firm profits in two ways: higher returns increase investment flows into the fund, and they may also increase incentive-based compensation to fund managers themselves. (20) These incentives and results are the same for other types of institutional investors, such as sovereign wealth funds, and all sizes of investors.
The theoretical literature to date does not identify what mechanism funds may use to soften competition. One popular model assumes the management of the competing firms maximizes the profits of their owners (the investors in the funds), which they can do because they know how much each investor owns of their rivals in the industry. (21) Alternative, and simpler, possibilities include: fund managers can encourage a common strategy among product market rivals; monitor product market rivals; tie compensation to industry performance; raise the patience level or value for the future of rival management teams; or, most easily, fail to mimic the actions of an owner that holds only one firm. All of these attributes appear as determinants of prices in economic models of multi-period competition. (22)
A growing empirical body of evidence suggests that horizontal shareholding has led to higher prices in product markets. At this writing, analysis of the effects of horizontal shareholding is nascent compared to the analysis of coordinated and unilateral effects from mergers. (23) Nevertheless, the academic literature finding adverse competitive effects is growing. (24) In highly concentrated product markets, shareholding by a small number of institutional investors is causally linked with reduced output and higher prices. (25) Studies to date have covered the banking and airline industries, with others underway. (26) The empirical literature also sheds light on a possible mechanism, with research demonstrating that increased horizontal shareholding increases absolute performance compensation, which softens product market competition. (27) Most of the studies use the MHHI, a modified version of the familiar Herfindahl-Hirschman Index, (28) to measure the extent of horizontal shareholding and common ownership. (29) However, more work needs to be done before this metric can be accepted as the preferred basis for empirical work or litigation. In particular, we do not yet understand whether or what size of harms arise from large common owners compared to small ones, what constitutes "large," the impact of total amounts of horizontal shareholding, or the effects of the ordering of owner size (for example, the largest owner compared to a particular percentage amount of ownership). MHHI does not take into account ordinal impacts of ownership or the impact of...