Andrew Khanarian

These past couple of years, academics have sparred over the question of whether common ownership of Corporate America by a handful of large institutional investors poses an antitrust risk. This theory gained significant traction with the “Azar Paper,” an empirical study linking airline prices with common ownership in the airline industry by institutional investors. The Azar Paper purportedly found evidence that increased common ownership by institutional investors causes higher prices and is therefore an antitrust concern. Responses to the Azar Paper range from agreement to skepticism to questioning its legal underpinnings to rejecting that correlation even exists (e.g. the opinion of institutional investors themselves). Despite the empirical and legal murkiness, this question of whether institutional investors are monopolizing Corporate America and pushing up consumer prices has crossed the radar of antitrust enforcers. But because most of the current academic discussion has been framed by the Azar Paper and the purported correlation between prices and common ownership by institutional investors, regulators and academics may be ignoring another potential antitrust concern: whether institutional investors are facilitating parallel conduct among competing companies.

Understanding the mechanisms of anticompetitive behavior 
Current literature focuses on common ownership by institutional investors as a potential violation of the Clayton Act, which prohibits stock purchases that substantially decrease competition. Generally speaking, extensive common ownership in an industry can decrease competition between commonly owned industry participants. But in the case of institutional investors, what are the precise anticompetitive mechanisms stemming from common ownership? One theory suggests that institutional investors disincentivize fierce competition among competing firms through compensation structures. However, the lack of a concrete understanding of how institutional investors work behind the scenes to decrease market competition remains a persistent criticism of the Azar Paper.

However, academics may be overlooking another possible role of institutional investors: channeling information among corporate competitors and facilitating parallel conduct. While institutional investors might not go as far as sharing daily prices, shareholder engagements over long-term issues can approach the specter of parallel conduct. Take climate change as an example. Some of the largest asset managers have made clear that companies’ responses to climate change is a top priority and they are engaging with boards on this topic. Hypothetically, an institutional investor getting commitments from the three largest energy companies to take certain actions to reduce carbon outputs by a certain percent by a certain date can skirt the antitrust boundary, especially if a causal relation to prices can be shown. Even if the various competitors do not directly conspire together, the Supreme Court has held that a central hub entering into separate agreements with various competitors in order to facilitate concerted action that raises prices can violate antitrust laws. While it is not clear how specific the conversations between energy companies and institutional investors are, institutional investors have been making concerted efforts across the energy industry on the disclosure front. It is important to determine if shareholder engagement goes further behind closed doors.

Focusing on shareholder engagement
One of the main ways that institutional investors communicate with boards is through shareholder engagement—when institutional investors flex their voting muscle in conversations with corporate boards. Two developments on the shareholder engagement front have increased the importance of studying these board-investor contacts. First, the number of shareholder engagements has increased over the last several years. For example, Blackrock’s total number of engagements in the Americas has almost doubled over the last two reporting periods, with “extensive” shareholder engagements on the rise as well. In effect, institutional investors are talking to more boards, and they are talking about more complex subjects. Second, the ongoing prevalence of activist fights has made institutional investors critical allies in the event of a board fight. If boards want institutional investors by their side, they need to start talking to them. If they do not, they risk losing their support. This trend changes the incentives of shareholder engagement. Wielding more leverage, institutional investors may be extracting more information from competing companies than before and having a greater influence on their actions.

While an increased focus on shareholder engagements is a theoretical shift from looking solely at common ownership, it is possibly consistent with the phenomenon observed in the Azar Paper. Boards are much more likely to communicate with institutional investors if the investor has a large stake in the company because the investor has more leverage when proxy season comes around. Thus, the previously reported correlation between common ownership and prices may have just misidentified the underlying causation. More information is needed to provide a definitive answer to this fundamental question of causation, including a more granular breakdown of shareholder engagements by industries.

Thinking ahead
There are also legal reasons to shift attention away from common ownership alone. The legal prohibition against anticompetitive common ownership in the Clayton Act has a specific carve-outfor passive investors. There are legitimate questions whether America’s antitrust laws even intended to reach deep into these types of capital markets transactions with little evidence of really harmful behavior. In other words, even if the theory in the Azar Paper is correct, so what? But a shift in research can help determine whether institutional investors are facilitating illegal parallel conduct that falls squarely within the prohibitions of antitrust laws.

An important question is whether the passive investor exception is due for some changes. For example, the current line between being a passive investor versus an active investor—which triggers an antitrust filing requirement—often turns on whether the fund participated in management decisions. However, antitrust authorities could consider tweaking the passive investor exception to account for the degree of shareholder engagement across an industry. For example, a certain amount of shareholder engagement with more than one company in the same industry should possibly affect an institutional investor’s status as a passive investor or at least require further disclosure. These discussions, however, can only take place if we have a greater understanding of shareholder engagement and its effects on competition.