Waiting for further proof of causal mechanisms before addressing the anticompetitive harm caused by horizontal shareholding is unjustified, just as it was when people argued we should wait for evidence of causal mechanisms before acting on empirical evidence that smoking causes cancer.
Over two dozen empirical studies have now confirmed the economic reality that common shareholding alters corporate behavior. This is hardly surprising. After all, institutional investors now cast 93 percent of shareholder votes at S&P 500 firms, and their investments have become so diversified across firms that we now have high levels of common shareholding.
One measure of common shareholding levels is the average weight that firms put on the profits of other firms, which ranges from 0 to 1, where 1 is the weight a firm would put on another firm it 100 percent owns. Assuming that each shareholder’s influence on a firm is proportional to its shareholdings, the average weight that an S&P 500 firm puts on the profits of other firms in their industry is now 75 percent. In other words, because of common shareholding, the average firm puts the same weight on other firm’s profits in its industry as it would if it owned 75 percent of the stock in those other firms.
Such common shareholding raises concerns, particularly when it involves horizontal shareholding—in other words, when the commonly-held corporations are horizontal competitors in the same product market. Numerous empirical studies have confirmed that such horizontal shareholding in concentrated product markets has anticompetitive effects.
Despite the wealth of empirical evidence showing that common shareholders do influence corporate behavior and that horizontal shareholdings have anticompetitive effects, some critics (including current officials at the US antitrust agencies) have argued that we should not act on these findings. They argue that first, we need more definitive proof of the causal mechanisms by which common shareholders influence corporate behavior. In my recent article The Causal Mechanisms of Horizontal Shareholding, I show that these critiques are mistaken.
The Mechanisms
Although critics express befuddlement about the causal mechanisms by which common shareholders might influence corporate policy, the mechanisms are neither surprising nor mysterious. They include all the ordinary mechanisms by which managers are incentivized to act in the interests of their shareholders: shareholder voting, executive compensation, the market for corporate control, the stock market, and the labor market. For decades, corporate law and economics scholarship has argued that this combination of mechanisms suffices to assure that managers are primarily influenced by the interests of their shareholders.
When the interests of a firm’s shareholders are changed by common shareholding, the above mechanisms indicate that managers will be primarily influenced by those altered shareholder interests. Because horizontal shareholders will, to some extent, be harmed when the firm competes with rivals that those same shareholders also hold, accountability to those altered shareholder interests will lessen firm incentives to compete.
As shown in my paper, there is ample theoretical and empirical proof that common shareholders can and do exercise influence via these conventional mechanisms. In addition, while none of the above mechanisms require direct communications from horizontal shareholders, there is ample evidence that such communications occur and that they can amplify the anticompetitive effects. Furthermore, horizontal shareholding can decrease competition by simply reducing shareholders’ incentives to pressure managers to compete.
In any event, the claim that antitrust enforcement requires definitive proof of causal mechanisms is misbegotten. Waiting for further proof of causal mechanisms before addressing the anticompetitive harm caused by horizontal shareholding is unjustified, just as it was when some argued that the empirical literature that showed smoking causes cancer did not justify regulating cigarettes until we had more evidence regarding the causal mechanisms.
Nor is it correct to say, as some do, that enforcement should focus on regulating particular causal mechanisms. Given that these causal mechanisms are the same ones used to desirably influence corporations to generally advance their shareholders’ interests, categorically banning any of them would be overbroad. The alternative of selectively banning only the anticompetitive use of any of these mechanisms would be ineffective. After all, evidence on the motives underlying the use of any of these mechanisms will generally be non-public or obscure.
In addition, banning only some mechanisms will simply cause horizontal shareholders to use others. Just as with antitrust merger analysis, enforcement should focus on changing anticompetitive market structures, not on behavioral remedies that are hard to police.
Many have claimed that none of these causal mechanisms can have anticompetitive effects because corporate managers have a fiduciary duty to protect the interests of their non-horizontal shareholders. One problem with this claim is that managerial judgments about competitive actions would be protected from any fiduciary duty claim by the business judgment rule. But the deeper problem is that non-horizontal shareholders affirmatively benefit from the fact that horizontal shareholdings reduce competition at both their own firm and rival firms simultaneously. Non-horizontal shareholders thus have no more incentive to object to anticompetitive horizontal shareholding than they would to an anticompetitive merger in which another firm acquired a majority interest in their firm and lessened competition in a way that increased the profits of both firms.
Indeed, the logic behind the claim that fiduciary duties to non-horizontal shareholder interests prevent any anticompetitive effects would, if accepted, imply that mergers that involve the acquisition of a controlling interest of less than 100 percent can never be anticompetitive. That position is implausible and clearly rejected by antitrust law.
The most influential critique of the causal mechanisms has been by professors Hemphill and Kahan. But they actually offer relatively little analysis of the theory and evidence on the process by which these causal mechanisms can influence corporations. Instead, they define causal mechanisms based mainly on their effects, and then they make various claims that such effects are either unproven or implausible. For instance, they claim that effects profitable for both horizontal and non-horizontal shareholders remain unproven. They likewise deny proof of any effects on the general tendency of a corporation’s managers to compete across the board. But, as I show in my paper, both those sorts of effects actually have been empirically proven.
Hemphill and Kahan also claim that causal mechanisms actively targeted at some of a corporation’s markets are implausible. In fact, empirical evidence shows that they actually occur.
The Incentives of Horizontal Shareholders to Influence Corporate Conduct
A different claim is that what makes the causal mechanisms implausible is that horizontal shareholders, especially index funds, lack incentives to employ any causal mechanism that would reduce firm competition. One version of this claim is that such institutional investors have negative incentives opposing the creation of anticompetitive effects. The other version is that institutional investors have insufficient positive incentives for creating anticompetitive effects.
The negative incentives claim says that any anticompetitive incentives from horizontal shareholdings are negated by those shareholders’ investments in vertically-related corporations. This argument ignores the fact that horizontal shareholders (even index funds) are generally not equally invested in vertically-related firms. For example, critics argue that horizontal shareholding cannot increase airline prices, because S&P 500 index funds also own other businesses that would be harmed by higher airfares. But as my paper shows, 95 percent of the cost of higher airfares would be externalized onto customers who are not in the S&P 500.
Even when horizontal shareholders are equally invested at a vertically-related level, the two layers of horizontal shareholdings in this scenario would compound, rather than negate, the anticompetitive effects. Furthermore, vertical shareholdings can create their own anticompetitive effects.
The claim about a dearth of positive incentives argues that index funds lack incentives to exert any affirmative effort to increase portfolio value by lessening competition or otherwise. The leading work for this view is by professors Bebchuk, Cohen, and Hirst, who claim that index funds lack sufficient incentives to exert effort to get firms to increase corporate value. Bebchuk and Hirst also argue that actual effort levels are low.
Economic theory indicates, however, that index funds have strong incentives to exert such effort because their anticompetitive gains are vast, while the incremental effort costs are generally zero or negative, as shown in my paper. In any event, horizontal shareholdings are generally not held by index funds and, even when they are, their shares are voted by fund families that also have active funds.
Moreover, Bebchuk and Hirst’s argument conflicts with copious empirical evidence. That evidence indicates not only that index funds engage in extensive efforts to influence the corporations they hold, but that their efforts are highly effective.
The Straw Man Argument
Both Hemphill and Kahan and Bebchuk and Hirst also argue that we should hold off on antitrust enforcement against horizontal shareholding because it would either greatly restrict fund diversification or discourage desirable institutional investor influence on corporate conduct. This argument is more than a little ironic, given its premise that institutional investors can influence corporate conduct, which is inconsistent with their claim that such influence is unproven or implausible.
In any event, this argument also rests on a false premise that tackling the anticompetitive effects of horizontal shareholding requires restricting either diversification or institutional investor influence. On the contrary, as I show, the natural remedy would just shift diversification to a different level and increase investment fund influence by having such funds concentrate their shareholdings in one firm per product market.
Accordingly, it is a straw man argument to claim that those who favor antitrust enforcement against anticompetitive horizontal shareholding want to diminish institutional investor influence. Antitrust enforcement would instead concentrate institutional investor influence into individual competitors in a way that increases efficiency. What antitrust enforcement would diminish is diluted influence by multiple institutional investors across competing firms, and only when such influence has inefficient anticompetitive effects.
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