I hate disagreeing with a guy as smart as Matt Bruenig, but a new article of his, Common Ownership And The New Antitrust Movement, is fundamentally off base. Bruenig contends that “shared ownership” of companies in industries contributes to monopoly/oligopoly behavior. Here is the core of his argument:
At the same time as the new antitrust movement has gained steam, others have been raising the alarm about the way companies are owned. Like the antitrust advocates, these folks also argue that our economy features an illusion of choice. But for them, the source of the illusion is not that massive holding companies own most of the brands we choose from. Rather, the illusion results from the fact that all public companies, no matter their size, are commonly owned by the same diversified investors.
The most popular example of this kind of common ownership has been the airline industry. There consumers can choose between companies like American Airlines, United Airlines, Delta Airlines, and Southwest. However, since the stock of these companies is all owned in significant part by the same set of investors, it hardly matters which one you choose: the money all goes to the same place.
Despite its lower stage of development, the movement against common ownership presents an interesting challenge to the new antitrust movement. If the common ownership critics are right about the source of our economy’s rot, then antitrust remedies aimed at increasing the number of firms in a given market will be inadequate. After all, multiplying the number of firms operating in a particular sector will do nothing about the fact that those larger number of firms will still be jointly owned by the same people who owned the smaller number of firms that preceded them.
I’ll go into more detail, but there are two big problems with the argument. The first is that he misconstrues what what public company ownership amounts to. Second, we see precisely the same propensity to create monopolies and oligopolies in private businesses, so why should ownership arrangements be depicted as an important factor?
On the first big problem, Bruenig ignores the vast economics and corporate governance literature on principal/agency problems with public stock ownership. The failing is not that too many of the same people own shares in similar companies (which is less true than he believes; I’ll get to that as well) but that the inmates run the asylum and the management gets to do as it bloody well pleases, save in extreme events where things get so bad that normally cronyistic boards of directors decide they must Do Something. One recent example is how long it took the Wells Fargo’s board to force CEO John Stumpf out.
This has nothing to do with the concentration in the fund management industry, which has increased greatly over the last 30 years, and everything to do with “how we do public share ownership, fund management and retirement investing” as in the US legal regime (such as SEC regulations, fiduciary duties, ERISA), and the behaviors that have developed around them.
The shareholders of public companies do not “own” them in the way Bruenig implies.
Equities are a weak and ambiguous legal promise, and public stocks even more so. They amount to, “You get a vote on a few important matters like big mergers and you get to choose among board members pre-screened by management but will favor their interest regardless, which really isn’t a choice. That vote can be diluted at pretty much any time. Oh, and you might get a dividend if we earn enough money and we are in the mood to give some of it to you.”
One of many indicators of how little power these supposed “owners” have: after the crisis, word got out that Lloyd Blankfein was going to pay himself a big bonus. Normally “don’t rock the boat” big institutional investors were so upset that the tromped into Blankfein’s office to tell him to cut it out. He paid himself his planned bonus anyhow.
The longer-form version of this argument comes in a 1994 Harvard Business Review article by Amar Bhide, Efficient Markets, Deficient Governance. A key section:
But there’s a catch: U.S. rules that protect investors don’t just sustain market liquidity, they also drive a wedge between shareholders and managers. Instead of yielding long-term shareholders who concentrate their holdings in a few companies, where they provide informed oversight and counsel, the laws promote diffused, arm’s-length stockholding.
Pension and mutual fund rules that require extensive diversification of holdings make close relationships with a few managers unlikely. ERISA further discourages pension managers from sitting on boards; if the investment goes bad, Labor Department regulators may make them prove they had adequate expertise about the company’s operations. Concerned about overly cozy relationships between unscrupulous fiduciaries and company managers, the regulators have effectively barred all but the most distant relationships.
If Bruenig’s thesis were true, you would expect to see different behavior in privately owned companies. But guess what? We come to the second problem: Private equity firms, who typically own a company 100% via a fund, are if anything even more eager monopolists than public companies. 1
One popular strategy is “roll-ups” which is buying up companies in a particular line of business. The objective is to achieve both operating efficiencies and “pricing power” meaning monopoly or oligopoly status. Moreover, these are often achievable in niches that most students of monopoly power would not recognize as capable of being dominates. Medical products and services have long been a target for private equity. For instance, private equity firms have targeted kidney dialysis centers because no one can or will travel far to get this treatment. If you can buy most of the centers in a geographic area, you can influence the pricing. Another area that private equity has targeted is pet products and services. They have even moved on to rolling up animal hospitals. From a 2014 press release:
Shore Capital Partners (“Shore Capital” or “Shore”) is pleased to announce that it has completed the recapitalization of Oak View Animal Hospital (“Oak View”), Patton Chapel Animal Clinic (“Patton Chapel”), and Williams Animal Hospital (“Williams”) to form Southern Veterinary Partners (“SVP” or the “Company”). The Company provides general practice veterinary services to companion animals including vaccinations, surgery, wellness exams, oncology, ophthalmology, allergy treatment and dermatology.
“As part of our sector-focused investment approach, we’ve spent significant time studying the veterinary services industry and we are confident that the sector benefits from a number of attractive industry dynamics and is ripe for continued consolidation.”
Bruenig ignores the fact that what every MBA in business school is taught can be boiled down to creating market inefficiencies. And this behavior long predates the professionalization of management. None other than Adam Smith said:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
We gave the financial services industry example in ECONNED:
But opacity, leverage, and moral hazard are not accidental byproducts of otherwise salutary innovations; they are the direct intent of the innovations. No one was at the major capital markets firms was celebrated for creating markets to connect borrowers and savers transparently and with low risk. After all, efficient markets produce minimal profits.
The problem is that we don’t tend to think of corporate behavior as oligopolistic or monopolistic when the results look consumer friendly. A highly differentiated product seeks to establish a market niche and appeal to a distinct set of consumers and charge a premium price for that. Apple’s celebrated iPhone is the archetypal example. A convenience store that can charge high prices by virtue of being open at 3:00 AM when all other stores nearby are closed is another example. But these practices generally take place in narrow markets and consumers perceive that even though the price is above a “market” price, the premium is justified due to the value attributed to the differentiated features (as witness how serious techies are mystified by the prices Apple gets consumers to pay for its computers). So this is the way businessmen try to change the playing field to favor them. To try to pin it on the stock market is backwards.
Bruenig’s line of thinking likely rests to a badly flawed study done years ago by a group of physicists on share ownership (I’m not going to dignify it by linking to it). I should have roused myself to debunk it then and didn’t, not that that would have made a difference. They did a network analysis and found that most shares were “owned” by remarkably few companies, such as Goldman, Blackrock, Fidelity, and Vanguard.
First, the entire analysis was garbage in, garbage out because the physicists had bad data. Retail shareholders almost without exception hold shares in ‘street name” and they would be attributed to the broker executing the trades for them, and not the actual owner. A study like this would be unable to correct for that. Retail shareholders own roughly 33% of common shares.
Those holders would most assuredly vote their own proxies. Moreover, these investors would be most likely to hold their shares over a longer period of time and be bona fide investors.
Pension and other government funds own 15% of all shares, international investors own 16%, and hedge funds own 4%. In addition, some large investors such as family offices and the larger endowments and foundations, have fund managers run dedicated funds. The sole investor would also vote its own proxy.
Second, “Blackrock” does not own shares. Blackrock manages funds, which are legal entities. They are managed by different managers with different mandates. The voting of those proxies is generally outsourced, either to outside proxy specialist firms or to in-house teams, or a hybrid. But the voting is highly rule-based, and the focus is on corporate governance matters. In other words, proxy votes, save on major mergers (and companies do tons of merger not big enough for shareholders to have a say) have very little to do with monopoly policy or not. As Bhide points out, the public ownership regime in the US (arms-length, transient investors) makes it impossible for companies to discuss their strategic plans with investors and get their input. Moreover, if a merger were to increase a company’s “market power”, an investor would favor that, regardless of whether it was a retail investor, a private equity fund manager, or a wealthy individual who owned businesses.
Third, despite the corporate governance theater of having experts figure out how to vote mutual and diversified institutional fund proxies, the reason that funds in these fund families generally vote their proxies in line with management recommendations is that they want to get the 401(k) business of big companies. They fear, almost certainly correctly, that defying them on the proxy side would lead them to getting removed from consideration for having their funds included in 401(k) offerings.
Finally, the average time of shareholding has collapsed. The average share holding time is now estimated at four months. So most investors aren’t owners, they are traders.
While I applaud the work being done by the anti-monopolists, this is a case of barking up the wrong tree. For instance, going after financial firms as monopolists or oligopolists in particular activities, like payment services, is a very important focus. But the fact that the trusts like Standard Oil, targeted by the Populists, were all created well before shares were regularly sold to large members of the public, is a strong indicator that businessmen understand the economic power of monopolies and oligopolies and will seek to create them regardless of the ownership structure. The rents they can extract are too lucrative for them to ignore the opportunity.
1 PE firms sometimes have different portfolio company ownership structures, for instance, letting some limited partners in the fund get a bigger stake in a particular company via a co-investment, or for large deals, inviting another PE fund in as a partial owner. But any limited partners who act as co-investors are not playing an active management role, and aside from a brief period of “club deals” that were deemed to run afoul of anti-trust laws, the number of private equity funds sharing ownership of a portfolio company is usually pretty small.