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FTC Hearings #8: Corporate Governance, Institutional Investors, and Common Ownership

· December 10, 2018

The eighth FTC hearing on Competition and Consumer Protection in the 21st Century took place at New York University School of Law with a robust discussion on corporate governance, institutional investors, and common ownership. The day’s panels examined concerns that acquisitions and holdings of non-controlling ownership interests in competing companies, for example by institutional investors, may have anticompetitive effects.

The hearing kicked off with opening remarks and a discussion between FTC Commissioner Noah Joshua Phillips and SEC Commissioner Robert J. Jackson Jr. Commissioner Phillips highlighted what he believed would be instrumental research before moving on to discussion of policy:

“There are several areas of research I would like to see developed before shifting to policy: first, how common ownership affects a broad group of industries; second, whether a clear mechanism of harm can be identified; third, a rationale why managers would put one set of interests over another; and fourth, a rigorous way of alleged anti-competitive harms against all the benefits of institutional shareholders.”

Commissioner Jackson also highlighted the issues that he believed were of utmost relevance to the hearings:

“One particular issue that demands more attention is the fact that today institutional investors pass votes in corporation elections on behalf on more than 100 million American families. They wield enormous influence on the future of our companies and communities but we’re not giving them enough information and they can’t make choices amongst index funds and it’s time for that to change. What I’m interested in is providing institutional investors with knowledge before they cast their votes in salient, clear terms why they’re casting those votes.”

Moving to the first panel of the day, there was a general consensus amongst the panelists that perhaps current proposals and extra regulation in efforts to combat against notions of anticompetitive effects would be detrimental.

David Hirschmann, from the United States Chamber of Commerce, believed in the benefits of shareholder engagement and argued that we should be looking at how common ownership harms competition through concrete evidence:

“Shareholder engagement does not drive down competition, in fact it can encourage and sustain healthy capital markets. Proxy survey says that 80% of companies engage year-round with institutional investors. All business models can be disrupted today, therefore Chamber is actively focused on removing barriers to innovation and growth. We should take an evidence-based look at common ownership and continue to challenge the science behind some of the things identified.”

Heather Slavkin Corzo, from AFL-CIO, had cautionary words about responses to concerns of anticompetitive activity and how that would affect investors’ rights:

“The SCC has taken a number of actions to scale back investors’ rights to raise concerns. This is opposite of the direction we should be headed. Individual investors are increasingly become more and more concerned about ESG issues. We should be encouraging that activity. In response to the notion that concerns about anticompetitive activity is to remove the rights of large institutional investors to participate in proxy voting…that is a serious concern for me. It would remove a lot of accountability. There is a balance that exists right now. It would be very disruptive to interfere with that.”

Allison A. Bennington, Partner and Chief Global Affairs ValueAct Capital cautioned against the current proposals:

“I’ve read the [academic] papers and my main concern is that the sorts of tweaks that are being proposed may be small for antitrust law but that’s absolutely enormous for the capital markets and for asset management. I do worry that this sort of theory, if put in place, would be tremendous damage to that system.”

The afternoon session of the hearing began with remarks from FTC Commissioner Rohit Chopra. Chopra focused his comments on how Wall Street incentives and corporate governance concerns could distort firm behavior stating that “the FTC should not and could not ignore these incentives since they may be the root cause of decisions that break the law.” He additionally stated his belief that there are many other corporate governance trends that require our attention, specifically emphasizing two: the explosion of corporate debt; and the distorted incentives in executive compensation packages.

After Chopra’s remarks, there were two quick presentations on common ownership from Daniel O’Brien at Compass Lexecon and Professor Martin Schmalz from the University of Michigan Ross School of Business. O’Brien focused his time on the application of the theory of partial ownership to questions about common ownership by institutional investors. In contrast, Schmalz used his time to discuss a much broader view on common ownership debating economic incentives for competition for common owners. He argued common owners have weak incentives to push for competition; instead, they have incentives to defer to the preferences of corporate managers who in turn have weak incentives for competition as well, thus creating an anticompetitive effect. His key insight was that nobody needs to soften competition if there are no incentives to compete in the first place.

Following the presentations was the second panel of the day, titled Theories of Competitive Harm from Common Ownership. Each panelist gave their broad views on the matter, then engaged in a panel discussion on whether or not there is a competition problem, how it might arise, and whether antitrust is really the appropriate remedy. Professor Menesh Patel, University of California, Davis School of Law, made clear the common ownership issue:

“relates to some of the very fundamental precepts of antitrust that we as antitrust scholars, practitioners, and regulators think about on a daily basis when we consider issues on antitrust, counsel our clients, litigate cases, and shape antitrust policy and enforce the antitrust laws… When these core principles of antitrust are applied to the common ownership question, the answer that is the outgrowth of that is an eminently antitrust answer and that antitrust answer is that it depends.”

There was general consensus from the panelists that the mechanisms by which common owners operate necessitate differing policy changes, and further research by academia and the FTC is key. Professor Scott Hemphill, from New York University School of Law, recalled the words of former FTC Chairman Robert Pitofsky in calling for a cautious approach to the application of antitrust law on this matter. Professor Fiona Scott Morton, from Yale University School of Management, shifting topic slightly towards horizontal shareholders and mergers, stated if we were to tighten up any marger standards, that could potentially create significant losses for consumers due to real efficiencies from those mergers. Professor Einer Elhauge, Harvard University Law School, followed up on Professor Morton’s comments arguing there is a tradeoff between what to do in merger analysis and in horizontal shareholding analysis. Lastly, William H. Rooney, of Willkie Farr & Gallagher LLP, closed with multiple quotes from Judge Frank Easterbrook additionally cautioning against over-enforcement due to its almost certain anticompetitive effects.

The final panel of the day was called Econometric Evidence of Competitive Harm from Common Ownership, and focused often on prices and the Modified Herfindahl-Hirschman Index (MHHI). While Professor O’Brien argued that it was not possible to determine the effects of common ownership by looking at the correlation between price and the MHHI, Professor Schmalz disagreed with O’Brien. Instead, Schmalz argued there is a connection between the two due to “decades of evidence that institutional ownership affects capital expenditures, payouts, merger activity, and more recently we have evidence that common ownership affects corporate financial choices, all of which affect competition.”

Professor Nancy Rose from Massachusetts Institute of Technology Department of Economics stated clearly she “doesn’t think that one can conclude that the case for anticompetitive effects of common ownership has been proven at this point.” She supplied two main points: first, the way we’re empirically implementing common ownership measures doesn’t reflect anyone’s incentives accurately; and second, MHHI measures have muddy interpretations. Others on the panel also spoke on the usefulness of MHHI, echoing Professor Rose that its usefulness is in decline.

In concluding, most panelists were in agreement that some degree of common ownership could have anticompetitive effects but the method of arriving at an accurate measurement and what that measurement means were still in debate.

The ninth set of FTC hearings, on data security, will take place on December 11-12 at the FTC Constitution Center.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.