An Ill-Advised Proposal
“A Proposal to Limit the Anti-Competitive Power of Institutional Investors” is the title of a working paper by a group of professors/researchers from the University of Chicago Law School and the Yale University. It was brought to my attention through a Wall Street Journal opinion piece (1/9/2017) by Barbara Novick, a co-founder and vice chairman of BlackRock, the world’s largest asset manager. The paper begins by alleging that the high level of ownership of companies by institutional investors (especially index funds) leads to “softer competition among product market rivals because of their significant ownership stakes in competing firms in concentrated industries.” The authors propose that the Department of Justice and the Federal Trade Commission should “take the lead by adopting a public enforcement policy of the Clayton Act against institutional investors…Investors in firms in well-defined oligopolistic industries must choose either to limit their holdings of an industry to a small stake (no more than 1% of the total size of the industry) or to hold the shares of only a single ‘effective firm’ per industry.” To cap it all off, “Investors that violate this rule face government litigation,” which of course means endless possibilities for fines and legal fees.
From basic economic theory, there is no question that concentration of ownership in an oligopolistic industry can lead to reduced competition and thus higher prices for their customers. This is what the 1914 Clayton Antitrust Act addressed, and the authors question if today’s institutional ownership situation violates the spirit if not the letter of the law. The first example that they cite is Warren Buffett’s acquisition via Berkshire Hathaway of major stakes in the four largest airlines in the U.S. They further point out that similar stakes are owned by BlackRock, Vanguard, Fidelity, and State Street, largely through their index funds. This begs the question of whether pressure has been applied to management to keep airline ticket prices high. However, Novick correctly points out that these institutional owners also own stakes in many other companies that benefit from lower airline ticket prices. Furthermore, there is no evidence of the involvement of these institutional shareholders with the airlines’ pricing and distribution strategies. To be sure, index fund managers have a valuable role to play in the traditional corporate governance issues addressed by shareholders.
The first part of the proposed remedy (limiting stake size to 1% of a given industry) is a non-starter because investors have entrusted these fund managers with a sum that is far larger than 1% of the entire capitalization of the stock market. It would essentially force companies like Vanguard and BlackRock to sell holdings in a way that would almost certainly harm their shareholders. After the fire sale, they would then have to close their doors to new investors, and they would be unable to maintain their current low cost structure (due to the loss of economies of scale) that benefits so many investors.
The second part (limited to holding shares of only one firm per industry) is even worse. It eviscerates the whole concept of indexing by vastly reducing diversification and forcing index managers to become stock pickers. Additionally, it puts investors into the position of having to pick the winning managers, a fool’s errand that more and more investors choose not to undertake, as evidenced by their ongoing migration to passively managed funds. As Novick said, index funds have “democratized” investing, and this proposal, however well-intentioned, would harm these investors to a far greater extent than whatever questionable economic benefit would result from limitations on ownership of companies. Anyway, with the new President and Congress, we believe it is unlikely to gain any traction.