Tuesday, August 18, 2015
A recent collection of papers have advanced the provocative theory that major institutional investors, such as BlackRock, Vanguard, and the like, effectively reduce competition in concentrated industries, including the U.S. airline sector, by holding stakes in competing firms. The economic theory is that by owning shares of all of the major firms within a given industry, these firms profit from most from increases to overall industry profit margins rather than from competition for market share among participants within the industry. While each individual firm should still have incentives to compete, management serves the interests of the company's largest shareholders, and thus disproportionately pursue market discipline strategies. This presumably explains patterns of executive compensation, which are tied more closely to industry performance, and the lack of increased economic output relative to recent profit levels.
Recent interest in this theory has been sparked by an econometric study of the U.S. airline industry finding airline fares to be 3-5% higher because of horizontal shareholdings by institutional investors. Posner and Weyl concisely summarize the findings and conclude that the U.S. congress should respond with legislative changes to the tax treatment of horizontal shareholdings by mutual funds. More recently, Elhauge has released a draft of a paper arguing that existing antitrust law provides sufficient authority to challenge horizontal shareholdings without legislative changes.
There is no indication yet that the DOJ is pursuing this theory in its current investigation of airline collusion, and the theory has critics who are skeptical that the government would take action that so directly threatens the very existence of index funds. Still, it remains an issue worth watching.