On Wednesday, March 9, 2016, Assistant Attorney General of the Antitrust Division Bill Baer testified before the Senate Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights that the Division is presently investigating minority common ownership of natural competitors in concentrated industries. These investigations are likely in response to two important papers—an economic analysis by Jose Azar, Martin Schmalz and Isabel Tecu, of minority common ownership that showed an increase in price to consumers where competitors in a market shared common minority shareholders; and a law review article by Einer Elhauge calling for increased antitrust enforcement against minority common ownership.
Professor Elhauge concludes that common ownership of competitors alone is sufficient to trigger the price effect and therefore harm consumers. His theory is essentially a per se theory. If you own shares in competitors, there will be a price effect, so the overlap must be eliminated. Professor Elhauge states that “active communication is unnecessary for horizontal shareholdings to have anticompetitive effects. Without any active communication, corporate managers know the identity of their shareholders and the fact that their shareholders also own shares in their rivals” p. 1270. He states further that “[m]anagers thus know that taking away sales from rivals imposes a cost on their shareholders…” Id. And lastly, he states that the “anticompetitive incentive created by this horizontal shareholding is purely structural, changing the price setting incentive of each firm acting separately” Id.
The economic paper is significant from a policy perspective. It is one of the first to identify an actual price effect related to common ownership and so an actual harm to competition. And it’s getting serious consideration from the academic, and now, enforcement community. Private equity firms that hold minority positions in natural competitors should be very concerned about the potential increased enforcement that may result from the papers.
Professor Elhauge is correct that the antitrust laws currently provide an effective vehicle for that enforcement as well. An activist shareholder that communicates a desire that his company stabilize price or margins in a particular market and communicates the same desire to that company’s competitor may in fact be acting as a hub of a conspiracy that violates Section 1 of the Sherman Act. Indeed, this model is the very model that resulted in Apple being held liable for price fixing in the ebooks market. Section 7 is also available. Section 7 prohibits mergers or acquisitions that substantially lessen competition or tend to create a monopoly. Section 7 applies equally to consummated transactions as it does to transactions subject to the notification provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
There are issues with Professor Elhauge’s approach, however. In the absence of evidence of communication between the minority shareholder and the competing firms, proving that it was the minority shareholding alone that caused the price increase will be much more difficult that Professor Elhauge anticipates. Competitors in concentrated markets are incentivized to act in parallel. Removing shareholder overlaps will not decrease concentration in the relevant product markets and therefore will have little effect on the ability of competitors to act in concert. The elimination of the overlap will not affect the structure of the market as it will not reduce concentration. What it does do is eliminate an avenue of communication between the parties and so a means to police an agreement.
More importantly, though, I do not agree that managers set price or other terms of dealing in order to enhance the profitability of large minority shareholders absent direction from those shareholders and his CEO. The individuals that set the workaday price on products in a large corporation are typically not the CEO. They are mid- to low-level managers who are most likely compensated based on their sales. They are incentivized to undercut their competitors’ prices because the profits they gain exceed the price reduction. Their compensation is likely not tied to how their competition is doing, and certainly not how a particular investment fund is performing. In fact, the only individuals the activist shareholders have sway with are the officers of the company—they are the ones that the activist can demand the board fire. If a CEO feels that her job is on the line, she will be the one that instructs the managers to harmonize price. It is that instruction that realigns the incentives of the manager. Rather than lose his job, he does what the CEO says. Absent the pressure from the CEO, the manager will seek to maximize his personal earnings. Compensating the CEO based on market performance may incentivize her to compete less, but at the end of the day, the Board will still be looking at the metrics of the company and assessing that CEOs performance. The Board owes a fiduciary duty to the shareholders, not to the market. Absent pressure from the activist, the CEO will have her company behave competitively.
Given the causal connection between ownership (without more) and the manager’s incentives to set price is so tenuous, it would appear that condemning joint ownership without more is overly broad. The better rule would be to see if there is an actual hub-and-spoke conspiracy going on. Is the activist inciting the two companies to act in parallel and is there an actual effect in the market. Is there real pressure being put on the CEO that is being telegraphed to the actual price setters in the company such that they are altering their behavior. Absent that evidence, the agencies should be loath to condemn common ownership because there may in fact be no competitive problem at all.
Private equity should not fear common ownership of natural competitors. If they do have such cross holdings, however, funds should either restrict activism or create separate clean teams for each holding. From the agency’s perspective, it might want to revisit the investment purposes only rules, possibly limiting its availability only to blind holdings. Any fund anticipating taking an activist role should seriously consider filing an HSR notification irrespective of whether it takes a formal role as an officer or director of the company.