Updated: Feb 13, 2022
INTRODUCTION This article deals with the question whether horizontal shareholding of competing firms by institutional investors in oligopoly markets can cause anti-competitive effects. The article aims to give a clear overview of the current lines of debate and their weaknesses and strengths. In order to do so in the most comprehensive way, it is necessary to explain the terminology of horizontal shareholding (I) and the controversy around its possible consequences on competition law (I.1). Afterwards, we will take a closer look at the most heated lines of debate (II) focussing on the issue of reversed causality (II.1) and especially the causal mechanisms through which horizontal shareholders could possibly influence their portfolio firms (II.2). Finally, we will take a very brief look at the relationship between horizontal shareholding and the current regulatory framework (III). I HORIZONTAL SHAREHOLDING: AN OMNIPRESENT PHENOMENON Horizontal shareholding is a form of common ownership where different investors (often institutional investors) hold shares in different horizontal competing firms. Implying that portfolio firms compete in the same market and at the same level of the supply and distribution chain. Scholars agree that horizontal shareholding is an omnipresent, structural phenomenon in different types of markets and across sectors. Horizontal shareholding does not exclude interlocking shareholding or cross ownerships. Furthermore, the literature recognizes the inclusion of venture capital firms. I.1 CONTROVERSY: EFFECTS ON COMPETITION LAW The controversy of the debate surrounds the question whether horizontal shareholding (hereinafter, HS) raises antitrust concerns. High quality empirical studies demonstrate that HS has anti-competitive effects in oligopoly markets but also the exact opposite. Consequently, there is currently no general rule that provides a clear cross-sectorial picture of the effects of HS on competition law. However, narrowing down the discussion to the empirical evidence does not do justice to the problem potential. A decrease in competition may lead to a deadweight loss for society. The debate becomes even more relevant as it seems that the current regulatory framework is inapt to deal with the issue (cf. infra). An analysis of the potential negative and positive effects of HS on the market is in order. First of all, it is argued that HS leads to anti-competitive unilateral effects. It is generally understood that investors seek profit maximization. However, the problem with HS is that one portfolio firm’s higher profits may lead to losses or less income in the competing portfolio firms, causing a decrease in the overall profit of the investor’s portfolio. As a result, managers may be more inclined to look for a new-equilibrium: instead of simple firm profit-maximization, they will now take into account the effects on competing firms (Cournot-Nash equilibrium). The portfolio firms could internalize the negative externalities. This may lead to higher price setting, territorial division etc. However, it is important to note that for this to happen the portfolio firm would need to be aware of the existing HS structure and behave shareholder oriented. Furthermore, the horizontal shareholders should dominate undiversified shareholders that only have an interest in one specific firm’s returns. In addition, it is argued that HS leads to or facilitates coordination effects between competing firms. It is important to note that the incentive for firms to coordinate is naturally present in the market. However, institutional investors may be incentivized to facilitate illegal (tacit) price-fixing agreements between competing firms to increase their overall portfolio profit. They may be positioned to do so in light of their close access to the management, knowledge on the industry’s strategies and the credibility of their advice. Yet, facilitators of the agreement are not always included in competition law and the line between illegal tacit agreements and legal tacit collusion is often blurred. Moreover, there is no scholarly consensus on the effects of HS on innovation. Some argue that HS may lead to a reduction in R&D to prevent larger competition between the portfolio firms. Oppositely, others claim that HS would lead to an increase in R&D, especially in markets where its spill-over effect is high as it would lead to an increase of profit for other portfolio firms. Also, institutional investors may lack the incentive to encourage reduced competition as it would lead to less innovation and a decrease in overall profits in the medium-long term. Other positive effects of HS have been put forward. Firms with horizontal shareholders are ought to invest more in the development and training of their employees as it is plausible that other competing portfolio firms hire them after their resignation. Furthermore, institutional investors engage in intensive market analysis, this may increase market transparency which could lead to more competition. Yet, more transparency could as well lead to more concentration between competing firms as the detection and sanctioning of deviant behavior from price fixing agreements becomes easier to manage. Some scholars claim that HS contributes to good societal development as institutional investors are likely to hold shares in very diversified firms, often with conflicting interests. For example, institutional investors may encourage firms with negative climate effects to reduce their emissions in order to lessen these effects on portfolio firms that are sensitive to them. II MOST HEATED ISSUES OF THE DEBATE II. 1 REVERSE CAUSALITY As mentioned, some of the empirical evidence suggests a correlation between HS and higher prices. However, correlation is not causation. A legitimate concern is raised as to whether HS might follow the price increase instead of causing it, seen as investors tend to buy shares in industries that are doing well. However, the empirical evidence supported by a natural experiment shows that these concerns are not valid. II. 2 CAUSAL MECHANISMS THROUGH WHICH HORIZONTAL SHAREHOLDING MAY AFFECT PORTFOLIO FIRMS’ BEHAVIOR As described above, horizontal shareholders could potentially benefit from coordination, unilateral and innovation effects of their portfolio firms. An incentive to influence firms behavior is established but the key question remains: whether or not these financial investors have the power to do so. Horizontal shareholders are often minority shareholders, typically owning only 5% of the shares of the firm, therefore lacking direct control over them. Some scholars further claim that the shareholders' interests are too disparate and generally lack enough influence to achieve the desired goals. This section aims to explore the mechanisms through which HS could potentially affect portfolio firms behavior and the counter-arguments to assess whether portfolio firms’ management is likely to act according to the interests of horizontal shareholders. A. VOTING STRATEGIES As direct control over the portfolio firm is unlikely, institutional shareholders may encourage anti-competitive behavior through other means of direct influence: voting. Horizontal shareholders could use their votes to push board members that favor their objectives. The potential effects increase when attendance of other shareholders is low. Especially, when diversified investors act en bloc and collectively hold more shares than undiversified investors. On the other hand, the institutional investors' interests might be too diversified, preventing their alignment. Also, studies show that instead of voting according to their portfolio’s value, diversified investors tend to simply follow management recommendations. B. DIRECT COMMUNICATION AND SELLING SHARES Another potential means of direct influence can be found in the direct interaction of the horizontal shareholders and the management, usually in an informal manner as direct communications with the intention to influence firm management are clearly prohibited by anti-competition law. However, there is only anecdotal evidence on this. Furthermore, diversified investors could potentially influence firm behavior by issuing public statements to enlighten their preferred course of action and threaten to sell their shares if that course is not followed. However, the latter seems only credible for active shareholders. Furthermore, institutional investors do not always dispose of the necessary human resources to use their theoretically available range of influence. C. INCENTIVIZING MANAGERS However, anti-competitive effects may also occur without direct influence on the management, even in the case of purely passive actors. First of all, informed managers may tacitly take into account the effects of business decisions on the portfolio of their major investors or those with aligned interests to avoid discontentment. However, the most powerful incentives for managers might follow from executive compensation. When compensation is tied to the performance of the firm it could align the manager's interests with those of shareholders. However, when the incentives are mostly based on industry performance instead of firm performance, like stock options, then the incentives may be more aligned with those of the diversified investors. This compensation mechanism is often used in markets with strong common ownership links and may come at the expense of other shareholders that want to engage in more aggressive competition strategies. However, this critique on HS presupposes that the managers’ own incentives to compete are not sufficient. Yet, managers face legally-enforceable fiduciary duties and a duty of care to all shareholders reducing the likelihood of favoritism towards diversified investors. However, these incentives could be less compelling in practice. Alternatively, Prof. Schmaltz claims that higher prices simply follow from higher costs. Although, he argues that these costs are the result of steeper managerial incentives caused by HS. D. PASSIVITY OF SHAREHOLDERS On the other hand, when diversified investors do not play an active role in pushing the management for more aggressive competition, their inaction may potentially lead to tacit collusion. Managers may be less likely to engage in riskful competitive behavior without pressure from shareholders. However, this idea is less developed and the structure of HS can be very complex: diversified investors may also hold shares in vertically competing firms. In this sense, their passivity could be explained as a form of cautiousness, as it becomes harder to predict the effects on their general portfolio. II.2.1 POTENTIAL LIMITATIONS ON THE INFLUENCE Aside from the thus far enumerated limitations, investors also face statutory limitations imposed by the capital market like the prohibition of insider trade which could limit their influence. Furthermore, strong corporate governance rules may achieve the same effect in certain markets. On the level of the portfolio firm, we have to assume that these firms are in principle still independent entities from a competition perspective, therefore we can not assume that the influence is as strong as it would be in the case of a single economic unit. Also, managers may have their own interests to coordinate with other firms. III REGULATORY FRAMEWORK If HS raises antitrust concerns then it is necessary to have a regulatory framework apt in dealing with it. However, HS seems to slip through the net. This paper will enumerate very briefly the existing regulatory framework while leaving the question regarding the necessity of new regulation open. First of all, anti-competitive agreements law is put forward. However, it is unclear which agreement could be prohibited: the corporate contract between the institutional shareholders and the portfolio firms or the contract in which the institutional investors buy shares. There seems to be a legal basis but the case law suggests otherwise and the consequences on the efficiency of capital markets could be enormous. Furthermore, as HS is a systemic problem it would lead to ad hoc enforcement. Secondly, as HS may facilitate firms to coordinate it could be a plus factor to prove concerted practices. Nevertheless, the former concerns apply. Furthermore, only the portfolio firms would be punished because diversified investors have bought their stock. Thirdly, if HS enables tacit collusion it could be sanctioned through the theory of abuse of dominant position. Yet, the high burden of proof and the absence of case law impedes the process. Fourthly, merger control law offers a more structural approach but the scope of the law requires the acquisition of a degree of control often absent in HS. Furthermore, the required substantial lessening of competition is often not found and the administrative burden would be high on both sides. Lastly, a market investigations regime may bring a solution. The competition authority could analyze HS to see if it has anti-competitive effects on a specific market. Yet, these investigations have a high administrative burden and only targets a specific sector, potentially excluding cross-sectorial effects from its scope. CONCLUSION Diversification of shares across and within markets is generally seen as a positive thing. However, horizontal shareholding may have a hidden social cost causing a rise in prices and a decrease of overall social welfare. Yet, there is no scholarly consensus on HS’ exact anti-competitive effects as many more market studies are required to provide a more definite answer. At the same time the current regulatory frameworks seems inapt to deal with the issue. In this light, the debate on horizontal shareholding and competition law remains controversial.