More than a century ago, a loophole in the antitrust laws helped trigger a giant wave of industrial consolidation,1 by which rival manufacturing firms in one industry after another combined into a single large enterprise that controlled industry prices.2 The loophole was closed,3 but not before the industrial landscape had been transformed to allow the widespread exercise of market power.4 A recent working paper by economists José Azar, Martin Schmalz, and Isabel Tecu raises the possibility that a modern-day antitrust loophole or blind spot has similarly been allowing firms to exercise market power across the economy.5
As is well known among financial economists but not previously recognized within the antitrust community, large and diversified institutional investors such as BlackRock, Fidelity, State Street, and Vanguard collectively own roughly two-thirds of the shares of publicly traded U.S. firms overall, up from about one-third in 1980.6 Moreover, financial investors have overlapping ownership interests in a substantial fraction of the equity of rival firms in a wide range of major industries, including airlines, banks, retail pharmacies, and technology firms.7 For example, BlackRock owns 5.9% of the equity in CVS, a pharmacy chain, and 4.44% of the equity in Walgreens, a rival pharmacy chain.8 Azar, Schmalz, and Tecu’s empirical study finds that as a result of overlapping financial investor ownership of major air carriers, airfares are 3% to 11% higher9 and the number of airline passengers 6% lower10 than they would be otherwise.
These preliminary results raise the possibility that overlapping ownership of horizontal rivals by diversified financial institutions facilitates anticompetitive conduct throughout the economy, and that the problem has been growing for decades, unnoticed until now.11 In his article Horizontal Shareholding,12 Professor Einer Elhauge dates the problem from around 1980.13 He contends that eliminating overlapping financial investor ownership will increase economic growth and employment, and reduce income inequality.14 He also argues that the problem can readily be solved through antitrust enforcement under the Clayton Act.15
My overall reaction to what Elhauge asserts is “yes, but.” As I will explain in Part I, market power has been growing, and the increase in overlapping financial investor ownership may well be an important cause, but we do not know how much that increase matters. As I will discuss in Part II, increased antitrust enforcement will be beneficial but not in the direct and immediate macroeconomic way that Elhauge supposes. In addition, I will explain in Part III why it may be more difficult to address overlapping financial investor ownership under the antitrust laws than Elhauge recognizes. I suspect Elhauge is right about the significance of overlapping financial investor ownership, and his proposed antitrust remedy could turn out to be effective, but as of today these are open questions.
I. Overlapping Financial Investor Ownership and Market Power
The exercise of market power has almost surely been on the rise in the U.S. economy since 1980. The increase in overlapping financial investor ownership is one of several plausible contributing factors.
One reason market power has been growing is the Supreme Court’s thoroughgoing transformation of antitrust rules, which began during the mid-1970s, along lines suggested by Chicago-School commentators.16 The new rules addressed the Chicago concern that the prior rules had a chilling effect on firms seeking to reduce costs and achieve other production efficiencies.17 But the new rules also systematically accepted a greater risk of false negatives, increasing the likelihood that firms would exercise market power undeterred by the antitrust laws. Not surprisingly, retrospective studies of merger enforcement find that today the marginal horizontal merger — the close case that government enforcers decide not to challenge — likely harms competition.18
The airline industry illustrates the modern limits of antitrust rules and enforcement in deterring anticompetitive conduct. The industry was prone to coordination more than a decade ago, when it had at least seven national network carriers;19 economic studies have found that multimarket contact among the airlines has facilitated coordinated conduct;20 and incumbent network carriers likely engaged in predatory conduct to discourage competition from upstart rivals in routes to and from their hub airports.21 Yet the government permitted further industry consolidation that has left the industry with only three national network carriers (American, Delta, and United) that collectively account for most airline passengers, especially for business travel; a large so-called “low-cost airline” (Southwest); and several substantially smaller low-cost airlines.22
The Justice Department challenged the most recent airline deal, the merger between American and U.S. Airways, but it ended up accepting a settlement that allowed the merger to proceed. The settlement did not directly address the competitive problems with coordinated conduct in the city-pair markets where, the government alleged, the merger would eliminate discount fares.23 After a decade of industry consolidation it was apparently too late for that. Instead, the Justice Department threw a “Hail Mary” pass: it attempted to support the growth of small low-cost airline rivals to the large hub carriers by requiring the merged firm to sell gates or takeoff and landing slots at seven major airports.24 That approach is a long shot in part because the fringe firms are not the competitive force they would have been absent the Chicago-influenced modifications to antitrust rules. These rules proved to be an insurmountable hurdle to an earlier government challenge to exclusionary conduct by a large network carrier that harmed low-cost airline competition.25
The contemporary problem of market power is not just the consequence of changes in antitrust rules that have reduced deterrence. Indeed, many likely sources of market power today do not necessarily violate the antitrust laws. Technological change has created more markets in which firms benefit from intellectual property protection or network effects.26 Many large information technology firms in network industries created since 1980 — perhaps including Bloomberg, Facebook, Google, Microsoft, and Oracle — likely exercise market power in some of their major markets for these reasons.27 In addition, the U.S. political process increasingly responds disproportionately to the concerns of the wealthy;28 those concerns may include protecting firms that are sources of existing wealth from new competition.
The recent economic research by Azar, Schmalz, and Tecu points to the possibility that the growth in overlapping financial investor ownership since 1980 has been an important additional source of market power.29 Some increase in market power would be expected: overlapping financial investor ownership has increased greatly and economic theory predicts it will lead to higher prices.30 Along with Elhauge, I suspect that the economy-wide consequences for the exercise of market power have been substantial. But the magnitude and scope of the problem in the economy as a whole have not been fully established in the economic literature. The empirical analysis in the airline study is careful, but the study is unpublished; two of the study’s authors have extended it to only one industry beyond airlines (banking);31 and other researchers have not yet attempted to replicate its results for those industries or for other industries with significant overlapping ownership by financial investors. In addition, the airline and banking studies do not account for the potentially countervailing impact of financial investors’ ownership interests in inputs, complementary products, and customers, or for the potentially countervailing impact of vertical integration by the firms into complementary lines of business.32
Further research will also be needed to identify the mechanisms through which overlapping financial investor ownership leads firms to raise product prices. Do the financial investors facilitate tacit or express coordination through communications with firm executives? Do the firms simply observe and take into account the overlapping financial interests of their major shareholders when making price and output decisions?33 Do they also decide not to take steps to compete with rivals not also owned by their major investors, or to exclude those rivals?
Elhauge’s article is predicated on the plausible assumption that continuing economic research will find that overlapping financial investor ownership is the source of substantial market power in industry after industry. But, as I will discuss further in Part III, he is more confident than I am that in antitrust litigation today, a court would be willing to conclude that the problem likely arises in industries not yet studied by economists.
II. Market Power, Antitrust Enforcement, and Macroeconomics
Elhauge seconds Professor Steven Salop’s and my previously expressed view that market power is one of the plausible causes of the increase in U.S. inequality over the past thirty-five years, and that antitrust enforcement could help address the problem.34 He also adopts Professor Paul Krugman’s view that the exercise of market power could explain the combination of high corporate profits and sluggish corporate investment during the current recovery.35 Elhauge emphasizes the possibility that overlapping financial investor ownership explains these trends in inequality and investment, though he also acknowledges the potential contribution of other factors.36
Market power cannot be the full story with investment. Depressed corporate investment since the June 2009 recession trough to a substantial extent is likely the product of macroeconomic conditions unrelated to the exercise of market power: for example, limited sales prospects during a sluggish recovery.37 Moreover, the growth in market power (which Elhauge dates from around 1980) likely began well before the observed divergence between profits and investment, which began around 2000 by one measure and around 2008 by another.38 It is possible that market power contributed to the current investment slowdown,39 but its importance relative to other factors has not been established. Even if greater market power is a substantial cause of depressed investment, moreover, that market power may not have derived from only the consequences of overlapping financial investor ownership. It could also or instead have resulted from other forms of exclusionary and collusive conduct undeterred by the antitrust laws, or from intellectual property rights and network effects.
To make plausible a direct connection between market power and overall business investment, Elhauge attributes observable trends in other macroeconomic measures during the economic expansion of the late 1930s — particularly trends in inflation and U.S. industrial output — to increased antitrust enforcement during the same years. I do not find this argument persuasive.
I agree with Elhauge that changes in antitrust enforcement regimes can have far-reaching economic impacts. Informal U.S. experiments with little or no antitrust enforcement demonstrate that without enforcement, firms can and do exercise market power, creating substantial and long-lasting harms.40 These include the period of ineffectual federal antitrust enforcement during the late nineteenth and early twentieth century and the experience during the early 1930s under the National Industrial Recovery Act,41 which allowed firms to agree industry-wide on how to compete, free of antitrust prohibitions.42
In 1938, as Elhauge observes, U.S. antitrust enforcement embarked on a major regime shift. Antitrust’s structural era began to take shape with the work of the Temporary National Economic Committee (1938 to 1940) and the enforcement efforts of Thurman Arnold during his tenure as Assistant Attorney General for Antitrust (1938 to 1943).43 But the change in the enforcement regime did not take place overnight. It was not fully established for more than a decade, until it was ratified by the courts, particularly in the United States v. Socony-Vacuum Oil Co.44 (1940) and United States v. Aluminum Co. of America (Alcoa)45 (1945) decisions, and ratified by Congress with the Cellar-Kefauver amendments46 (1950) to the Clayton Antitrust Act.47
The shift in enforcement regime was associated with the development of an informal national understanding about the role of large firms in the economy — what I have termed a political bargain — under which large firms would in general be kept free from economic regulation other than antitrust enforcement.48 This microeconomic policy framework generally allowed firms to capture scale economies while limiting their exercise of market power. It was undoubtedly one important reason for economic prosperity and growth in the decades that followed, and it would not be surprising if aggregate output and growth economy-wide were higher over the past seventy-five years than they would have been had such an informal national understanding not emerged during the 1940s.
Elhauge does not view the change in regulatory regime as a process lasting at least a decade. Instead he treats it as a sharp political shock largely occurring over a few months during mid-1938. During those months, Assistant Attorney General Arnold and President Franklin Roosevelt gave speeches signaling increased antitrust enforcement, and the Justice Department began to initiate a series of industry-wide antitrust suits. Elhauge attributes key features of the 1938 economic recovery to a shift in business expectations resulting from this shock.
I am not convinced, for two reasons. First, businesses could not reasonably have concluded that the change in competition policy introduced in 1938, however dramatic, would be long-lasting, given that the antitrust laws had been effectively neutered even more dramatically only five years before.49 It would take more than a decade for all aspects of the new antitrust regime to fall into place and for new expectations to solidify.50 As a result, the bulk of the deterrent effect of the new antitrust era on anticompetitive conduct would likely have been deferred, making it implausible that this regulatory development would have had short-term macroeconomic consequences during 1939 and 1940.51
Second, Elhauge’s supposed identification of the short-term macroeconomic effects of antitrust enforcement rests heavily on his claim that the economy’s overall price level declined during the 1938–1941 recovery.52 If prices fell while economic growth was surprisingly strong, that would indeed suggest the economy received a positive supply-side macroeconomic economic shock,53 and increased antitrust enforcement could be one candidate source.54 But the overall price level did not actually decline during the 1938–1941 recovery period;55 it is better to describe it as not changing.56 Moreover, there is no puzzle about the late 1930s price level to resolve by postulating a positive shock to aggregate supply: the evolution of economy-wide prices during the 1930s, including the late-1930s recovery period, is well explained without reference to post-1937 antitrust enforcement.57
I do not dispute Elhauge’s view that market power and antitrust can have large effects on overall economic performance. But I do not think that the evidence he marshals is sufficient to demonstrate the stronger claim he makes for a direct connection close in time between increased antitrust enforcement and macroeconomic outcomes.
III. Antitrust Enforcement and Overlapping Financial Investor Ownership
When he turns to remedy, Elhauge argues that substantial overlapping financial investor ownership violates the Clayton Act, a century-old antitrust statute that addresses mergers, joint ventures, and asset or stock acquisitions.58 His main concerns are to explain why the statute’s exemption for passive investment does not insulate diversified financial institutions with shareholdings in horizontal rivals from liability, why the filing exemption for passive investment in the premerger notification process set up pursuant to the Hart-Scott-Rodino Antitrust Improvements Act59 is no bar to a Clayton Act suit, and why the statute of limitations for private damage actions does not necessarily prevent challenges to stock acquisitions made more than four years in the past.60
Elhauge does not discuss a range of problems that could make successful Clayton Act enforcement more difficult than he supposes. In his view, antitrust enforcement would be straightforward: a federal antitrust enforcement agency, state government, or private plaintiff would meet its burden of production by demonstrating that the overlapping financial investor shareholdings lead to high and increasing market concentration, using a metric similar or identical to the one employed by Azar, Schmalz, and Tecu in their airline research. The defendant financial firms would be unable to meet their burden of production in response, according to Elhauge, because overlapping financial investor ownership creates no integrative efficiencies.61 As a result, any overlapping shareholdings sufficiently great to satisfy the plaintiff’s initial burden would be summarily condemned, without need for the plaintiff to demonstrate that prices rose.62
Under Elhauge’s analysis, competitive overlapping shareholdings would create a rebuttable presumption of competitive harm, but the presumption would likely be nearly irrebuttable in practice. In consequence, only a few lawsuits would be necessary. Institutional investors would quickly come to recognize the likelihood of this outcome and would solve the problem by divesting substantial overlapping shareholdings or committing not to vote their shares.63 This approach could work. But whether it would do so quickly is uncertain for a number of reasons that Elhauge does not address.
First, enforcers and courts may be unwilling to conclude that competition will be harmed if the financial investor defendants can show that the exercise of market power in those businesses would harm other investments in their portfolios, such as their ownership stakes in suppliers, purchasers, or sellers of complementary products.64 The greater those investments, the less likely that the financial investors would benefit overall if the rival firms in which they invest compete less aggressively. It then becomes less likely that overlapping financial investor ownership in horizontal rivals will harm competition.65
Second, the potential breadth of the shareholdings prohibition may make enforcers and courts cautious, even when overlapping financial ownership is likely to harm competition. Under Elhauge’s approach, overlapping financial ownership may violate the Clayton Act when industrial firms with common financial investors compete head-to-head only in markets that amount to a small portion of the business of each.66 For example, if Coca-Cola bought or built a brewery, it could be illegal for financial investors to purchase substantial shares in both Coke and SABMiller, an international brewing firm that owns the Miller brand.67 If overlapping financial investor ownership of Coke and SABMiller violates the Clayton Act, moreover, financial investors owning Coke shares may also be barred from acquiring shares in Altria, a tobacco firm with a substantial ownership stake in SABMiller.
Third, it may be impossible in practice to attack some harms to competition from overlapping financial ownership under Elhauge’s approach. Suppose overlapping financial investor ownership harms competition in some markets by discouraging firms from entering markets that are important to other firms in which their financial investors also have a stake. This possibility is not hypothetical: for example, the Justice Department identified similar conduct among the major airlines.68 Yet the absence of current head-to-head competition may prevent the plaintiff from establishing that overlapping financial investor ownership has generated an increase in concentration sufficient to meet the plaintiff’s initial burden. Even when one or both firms have some assets that could be used to enter the other firm’s markets, demonstrating that their potential rivalry would constrain prices absent overlapping financial investor ownership would often be challenging.69
Fourth, overlapping financial ownership created by diverse acquisitions by industrial firms may be insulated from effective antitrust challenges under Elhauge’s theory. Suppose that financial investors do not alter the stock holdings in their portfolios, but that one of the industrial firms held in the portfolios of many financial investors acquires a new business previously owned by a different set of investors (as might be plausible if the acquired firm had been privately held). For example, suppose that Ford was privately held, then acquired by Microsoft. Competition in automobiles could be lessened if that business acquisition places Microsoft in head-to-head competition with another firm also in the portfolios of those financial investors, such as General Motors. But the overlapping financial investor interests would be insulated from antitrust attack under the Clayton Act because the financial investors did not acquire new equity stakes; there would be no stock acquisition to challenge.70 It is possible that the adverse consequences of overlapping financial investor shareholdings in Microsoft and General Motors could instead be reached under Sherman Act section 1, however.71
Fifth, three efficiency defenses proffered by financial investor defendants may give enforcers and courts pause, at least as a matter of first impression.72 The benefits to capital markets on which these defenses are predicated — improved corporate governance, greater diversification, and enhanced financial market liquidity — are widely recognized by financial economists as important to the overall economy. But, as discussed below, these benefits may not hold up if proffered as the bases of defenses in antitrust litigation about overlapping financial investor ownership.
To begin with, financial firm defendants may claim that overlapping financial investor ownership creates efficiencies by improving corporate governance. As the defendants may point out, overlapping financial investor ownership may increase the number of investors with substantial financial stakes in each industrial firm. If some large financial investors are more willing than others to undertake active monitoring of managerial decisions (for example, through investor communication with firm management or investor voting of equity interests)73 in order to raise the value of the financial investors’ equity investments, then overlapping financial investor ownership would increase the pressure on the managers of industrial firms to maximize shareholder value through cost-cutting or the pursuit of other operational efficiencies.
This corporate governance defense may get a hearing, but it is unlikely to be persuasive. Although a prohibition on overlapping financial investor ownership would be expected to reduce the number of large financial investors owning the shares of any given industrial firm, the remaining large investors, at first approximation, would each be expected to own substantially more shares than before (with little change in the total value of the firm’s equity held by large financial investors).74 With larger ownership stakes, each of the remaining investors would have a greater incentive than before to monitor firm management, so corporate governance would more likely improve overall, contrary to what defendants might contend.75
Financial defendants may raise another efficiency defense involving capital market benefits: they may claim that overlapping financial investor ownership improves the functioning of capital markets and encourages investment by making diversification less difficult or less expensive for investors. Financial investors benefit from owning stock in multiple airlines, for example, because they bear lower undiversifiable, firm-specific risks in their portfolios relative to those that they would bear if limited to owning stock in only one airline.76 The airlines and airline passengers arguably benefit too: the ability of financial investors to diversify risks by holding shares in multiple airlines would tend to lower the cost of capital to airlines and increase airline investment.77 But the diversification benefits to the defendant financial investors of holding shares in two competing air carriers are limited, because airline profits and equity values are to a substantial extent the products of industry-wide trends,78 and because the defendant financial investors may be able to diversify their portfolios comparably by holding shares in other industrial firms.79
The diversification defense also supposes implicitly that the individuals, institutions (such as pension funds), and firms that invest through the large financial institutions (such as BlackRock or Fidelity) that are the likely antitrust defendants have no inexpensive alternative in order to achieve the benefits of portfolio diversification. Yet if overlapping financial investor ownership of competing industrial firms were prohibited, whether for a specific industry or overall, and if an individual financial institution could not diversify its portfolio to the same extent as before, the individuals and firms that now invest through the funds offered by defendant financial institutions could diversify their portfolios in other ways, such as by investing in multiple mutual funds or purchasing shares in multiple exchange-traded funds.80 I doubt that the resulting reallocation of financial investments would make much difference to the costs to industrial firms of raising capital by issuing equity.81 Even if antitrust enforcement leads to the divestiture of overlapping financial investor ownership in multiple industries, moreover, any capital market consequences may well be too diffuse to consider in antitrust litigation.82
Financial investors may offer a third efficiency defense by claiming that overlapping financial investor ownership increases liquidity in equity markets, thereby encouraging investment. The defendants may claim that their ability to own shares in multiple airlines, for example, means that equity transactions involving airline stocks will, on average, involve more financial investors buying and selling smaller shareholdings than would be observed if each financial investor was limited to owning stock in a single airline.83 Accordingly, by retaining the ability to own shares in multiple airlines, the equity markets for airline shares would be more liquid, as each smaller transaction would be expected to have a smaller effect on stock prices.84 As a result, defendants may say, overlapping financial investor ownership lowers the cost of capital for airlines. Again, I doubt that this possibility would make a practical difference to the airlines’ cost of capital. In addition, any reallocation of investments that takes place as the individuals, institutions, and firms now investing through large financial firms like Fidelity and Vanguard work out new ways of diversifying their portfolios could reduce the average size of equity transactions, thereby restoring any lost liquidity and preventing a liquidity-related increase in the cost of capital for airlines.85
If capital market efficiencies are raised in a defense of overlapping financial investor ownership, a court would likely find the benefits within the relevant industry to be small relative to the anticompetitive harm. Any reduction in the airlines’ costs of capital, for example, is unlikely to enhance those firms’ ability to compete sufficiently to outweigh the competitive harms found by Azar, Schmalz, and Tecu: a 3% to 11% increase in airfares and a 6% reduction in the number of airline passengers served.86 A court would be expected to give the financial investors an opportunity to make out these defenses, but I am skeptical that any would prevail.
Sixth, and finally, the empirical economic literature relating overlapping financial investor ownership to higher prices is in its infancy. Even if a court is persuaded by the existing empirical studies that suggest that overlapping financial investor ownership has led to substantially higher prices in the airline and banking industries, it may not be willing to conclude that the same outcome would occur in other industries without understanding the mechanism by which competition was harmed in airlines and banking. Without such an understanding, a court may not be willing to extrapolate the results from two industries onto a third, and may not be confident that it can frame an appropriate remedy.87 Under such circumstances, it may be unwilling to permit plaintiffs to satisfy their initial burden simply by demonstrating overlapping financial investor ownership.88
Over time, these difficulties may be overcome. Some of these issues could be resolved through case-by-case adjudication. Addressing others may require additional economic research. But, in the meantime, some or all of these problems could make successful enforcement more difficult than Elhauge supposes.
Elhauge prefers case-by-case antitrust enforcement to legislative action,89 which he considers politically infeasible.90 He does not consider another alternative for addressing the market power concerns arising from overlapping financial investor ownership: the exercise of the Federal Trade Commission’s dormant competition rulemaking power.91 This alternative is worth exploring given the potential problems with case-by-case antitrust enforcement.92
IV. Conclusion
The economic research on which Elhauge’s article is based adds to the contemporary indictment of the financial sector. Since 1980, finance has diverted massive resources from other sectors of the economy without becoming more productive at its central task of financial intermediation.93 The recent studies by Azar, Schmalz, and Tecu suggest that the concomitant growth in overlapping ownership of horizontal rivals by diversified financial institutions may facilitate anticompetitive conduct economy-wide.
Elhauge has successfully highlighted the potential significance of these market power problems and identified one possible way that antitrust enforcement could respond. His provocative suggestion that antitrust enforcement against overlapping financial ownership may transform the economy by lowering prices markedly, reducing inequality substantially, and increasing business investment could turn out to be correct, and the antitrust enforcement actions he proposes could succeed as remedies. If so, his article on horizontal shareholdings may appear prescient in retrospect.
* Professor of Law, American University Washington College of Law. The author is grateful to José Azar, Benjamin Leff, Einer Elhauge, Andrew Gavil, Robert G. Hansen, Steven Salop, and Martin Schmalz.