Regulators consider whether mutual funds’ common ownership of competing companies is bad for consumers.
Nearly half of American households have staked their financial futures in diversified asset pools called mutual funds—to the tune of $22 trillion, according to a recent estimate. In the process of building these funds, mutual fund companies have become the largest shareholders of the world’s most valuable public companies.
Although many have touted the social benefits of mutual funds—such as their accessibility to investors and diversified risk—critics including antitrust scholars Einer Elhauge, Herbert Hovenkamp, and Fiona Scott Morton argue that the power of mutual fund companies may be bad for consumers.
They have expressed concern over the extent to which the same groups of investors have become the largest shareholders in competing companies, a phenomenon many have dubbed “common ownership.” Through their common ownership of competitors’ shares, mutual funds are not just entitled to vote in the companies’ board elections. They can also leverage their influence as large shareholders to meet with companies’ management and offer suggestions on corporate decision making.
Critics of common ownership believe that it allows mutual funds to influence competing companies’ policies and, in theory, send a signal to boards that competition is not desirable. Consequently, the critics say, consumers face higher prices from decreased competition.
For example, by one estimate, mutual fund companies’ common ownership of the airlines Delta, Southwest, United, and American accounts for increases in ticket prices ranging from 3 to 12 percent. A similar study suggests that delays in the introduction of generic drugs, at an estimated cost to American consumers of $3.5 billion a year, stem from common ownership of pharmaceutical companies.
The critiques of mutual funds’ power, along with the flurry of responses from their skeptics, have made for an ongoing debate over whether common ownership reduces competition. Professors, economists, lawyers, and a federal appeals court judge have weighed in on the issue. U.S. regulators have taken notice, too. Although neither the Federal Trade Commission (FTC) nor the U.S. Securities and Exchange Commission (SEC) have taken a stance in the debate, the FTC recently held a hearing on whether common ownership harms consumers.
“In my view we are at the beginning, not the end, of the debate on concentrated common ownership,” said SEC Commissioner Robert Jackson, who gave opening remarks at the FTC hearing.
Those who find that common ownership suppresses competition begin with the premise that mutual funds seek to make money on their overall portfolio of investments, not just on individual companies. If a mutual fund holds stock in both Southwest and American Airlines, the theory goes, the fund manager would prefer for both companies to be as profitable as possible. Rather than see the airlines compete for customers on price, the mutual fund would want to vote its shares in each airline in favor of board strategies that maintain high prices.
The paper credited by regulators for sparking the debate over common ownership used this theory to suggest that common ownership can help explain rises in airline prices. Using a natural experiment to identify their effects, business school Professors José Azar and Martin Schmalz and economist Isabel Tecu suggest that higher rates of common ownership have led airlines to increase ticket prices. Their research design has since been applied to the pharmaceuticals context by two teams of scholars, who both reached similar conclusions that common ownership harms consumers.
Azar, Schmalz, and Tecu acknowledge an open question in their analysis: whether mutual fund companies actually do seek to maximize portfolio value rather than the value of individual companies. They left room for further research into the precise ways that common ownership affects or does not affect competition.
Meanwhile, antitrust scholars Elhauge, Hovenkamp, Scott Morton, and others have considered how regulators might respond to anticompetitive common ownership.
They have argued that regulators could confront mutual funds’ common ownership of competitors using Section 7 of Clayton Antitrust Act, which prohibits anticompetitive acquisitions of companies, whether partial or complete. Although Section 7 exempts share purchases “solely for investment,” the Act should not be construed to immunize mutual funds that use their shares to influence a company’s behavior, according to the scholars. Rather, they say, Section 7 and its interpretation by courts suggest that if a mutual fund uses its stakes in companies to “substantially lessen competition,” it should face federal antitrust liability.
One group of professors goes further: They argue that regulators should use their authority under the Clayton Act to bar mutual fund companies from holding more than 1 percent of competitors, at least if they compete in concentrated product or service markets. According to the professors, such a policy would prevent the purported anticompetitive effects of common ownership and still allow companies to build diversified mutual funds.
Other academics have hesitated to conclude that common ownership needs to be regulated. A group of antitrust economists argues that Azar, Schmalz, and Tecu’s analysis contained statistical flaws. Using an alternative statistical design, the economists find no relationship between common ownership and anticompetitive effects.
From a corporate governance standpoint, antitrust scholar Scott Hemphill and corporate law Professor Marcel Kahan question Azar, Schmalz, and Tecu’s treatment of mutual fund companies as monolithic organizations. Rather, Hemphill and Kahan argue that the companies are umbrellas for many kinds of funds that earn money in different ways. The managers of those funds face different incentives—and some managers may prefer to maximize their return on one company at the expense of its competitors, according to the professors.
For example, suppose a mutual fund company’s managers earn more fees from an actively managed fund that happens to hold more shares of Southwest Airlines than it does of American Airlines. In contrast, the company’s low fee, passively managed index fund might hold shares of both airlines in closer proportion. In the latter fund, a manager might prefer for the airlines to refrain from competing, as gains in the fund’s holdings of one airline would be wiped out by losses in the other. But, on the whole, the mutual fund company may nevertheless want Southwest to beat out American because its more lucrative fund holds more Southwest stock.
Separately, one paper questions whether the government even has the statutory authority to regulate common ownership. In that paper, Judge Douglas Ginsburg of the U.S. Court of Appeals for the District of Columbia and Keith Klovers, an attorney-adviser at the FTC, argue that common ownership falls outside of the scope of the federal antitrust statutes, at least as they have been interpreted by the courts.
Elhauge, in response, has refuted criticisms of his and others’ call to regulate common ownership. In a recent paper, he provides reasons why statistical critiques of Azar, Schmalz, and Tecu are overblown, why fund managers actually do face an incentive to suppress competition, and why the jurisdictional concerns raised by Judge Ginsburg and Klovers do not hold water. Reiterating his belief in the anticompetitive effects of common ownership—or, as he calls it, “horizontal shareholding”—Elhauge has issued a renewed call for regulation.
“Horizontal shareholding poses the greatest anticompetitive threat of our time, mainly because it is the one anticompetitive problem we are doing nothing about,” he writes. “This enforcement passivity is unwarranted.”
The debate over common ownership’s significance continues as regulators in the United States and abroad consider whether and how to respond to issues associated with mutual funds’ common ownership of competing companies.