Distribution, Competition, and Antitrust / IP Law

Are Mutual Index Funds Anti-Competitive?

They may be, according to a thought-provoking article by Harvard Law School Professor Einer Elhauge entitled “Horizontal Shareholding as an Antitrust Violation” (July 21, 2015), available here.

In a nutshell, Professor Elhauge’s argument is:

  • Large institutional investors (mutual funds and, presumably, ETFs) own fairly large shareholdings in horizontal competitors throughout the economy – for example, from 2013-15, seven shareholders controlled 60% of United Airlines, 27.5% of Delta airlines, 22.3% of Southwest Airlines, and 20.7% of JetBlue Airlines. The problem is particularly acute for index funds, which routinely invest in horizontal competitors in an industry;
  • Basic economic theory suggests that this sort of “horizontal shareholding” may result in diminished incentives to compete – because if firm A gains profit/market share by lowering prices, shareholders who own stock in both firm A and competitor B (or competitors B and C, or B and C and D, etc.) will see at least some loss in profitability in their other holdings;
  • Recent econometric studies suggest that in markets where shareholdings are concentrated in this manner, higher prices are not only observed, but are also attributable to the “excess” concentration;
  • These horizontal shareholdings explain some persistent economic puzzles, including (a) executive compensation being based on industry performance, rather than corporate performance, (b) the failure of high corporate profits to lead to high growth, and (c) the recent rise in economic inequality; (*)
  • Antitrust law – as it is currently formulated – can reach these horizontal shareholdings under Clayton Act Section 7, and the passive investor exception is not a bar to legal action, because (a) funds actively insert themselves into management discussions and so are not purely “passive” and (b) even if they are, the passive exception does not apply if the acquired stock is actually used (by voting or otherwise) to lessen competition substantially or to attempt to do so; and
  • Regardless of the Section 7 passive investor exception, Sherman Act Section 1 and FTC Act Section 5 apply to horizontal shareholding acquisitions.

As I said, provocative and intriguing stuff. But I have some questions.

  • Mutual fundsandETFs are owned (I assume predominantly) by individuals. Many (most?) of those individuals are also employees in the labor markets. Why would those owners want to see unduly high executive compensation, lower growth, or higher income inequality? If the answer is there is an information gap or asymmetry, why does it persist? If firms subject to fund ownership can figure out (even without communication) that they shouldn’t vigorously compete due to their common owners, why can’t mutual/ETF fund managers figure out that fund owners don’t want fund managers tocontribute to anticompetitive behavior?
    • Perhaps most stock is ultimately held by investors who benefit more in their role as investors than they do as workers.  Additionally, perhaps there is a collective action problem at the fund investor level – even though we would all be better off with a stronger economy, when choosing to invest money, we each have incentives to pick the fund with the highest rate of return.
  • All things being equal, the higher level of horizontal holdings, the moremonopoly-level profits one would expect to be extracted. Yet we apparently see horizontal shareholdings by funds in the 4-6% range (and in any event usually under 10% for any particular fund). If the horizontal ownership strategy were so successful, wouldn’t we expect to see even higher ownership levels? What does it mean that we don’t?
    • Perhaps regulatory obligations kick in at 5% and 10%, and over 15% may require a Hart-Scott-Rodino filing. If there’s no current appetite to bring enforcement actions in this space, however, I wouldn’t think these modest expansion barriers (filing requirements) would be much of an impediment to larger holdings.
    • Perhaps it would be just as profitable to have 5% stakes in four anticompetitive marketsrather than a 20% stake in one anticompetitive market. But:
      • If 4×5% is just as profitable as one 20% holding, doesn’t that suggest that 20×1% is also just as profitable? But we apparently don’t typically see 20×1%, and if we did, it’s not clear to me it would be objectionable. It seems to me that, if the horizontal shareholdings theory is generally correct, one would expect to see higher rates of return (and more anticompetitive effects) with higher levels of shareholding (though the effect may not be linear). So I still wonder about the relatively low levels here.
      • Also, it may be more difficult and expensive to amass and manage a portfolio of many small holdings as opposed to one larger one. Again, if that’s true, how do we explain the absence of larger horizontal shareholdings?
    • Is there anything in securities law and regulation that allows for horizontal ownership and/or communication with management and that would otherwise preempt the application of antitrust law?
    • Would antitrust enforcement lessen fund diversification? And if so, can the pro-competitive effects of antitrust enforcement be balanced against the reduction in diversification in a quantitative manner?
    • To the extent there is an issue, can it be solved by giving funds a choice – either limit their holdings, or agree not to become actively involved in firm management or governance? The article suggests the answer may be yes – “if index funds alone would create a problem of anticompetitive horizontal shareholding in a concentrated market, and those index funds feel the benefits of diversification across all firms in that market exceed the benefits of influencing corporate governance, they could commit not to communicate with management or vote their shares.”

In short – it’s a very interesting theory. But it’s early days, and I think we need some more consideration – and evidence – to evaluate it.

P.S. – The paper also argues that increased antitrust enforcement in the 1930s under Thurman Arnold was a substantial reason for the United States’ emergence from the Great Depression. Certainly the timing of AAG Arnold’s appointment lines up neatly with the decrease in the unemployment rate. As they say, correlation is not causation – but again it’s a very interesting point.

(*) The basic arguments are that (a) the use of industry performance measures is not a bug but a feature for institutional investors who are invested across the industry, because managers who increase individual corporate performance by competing with rivals decrease institutional investor profits across the industry by decreasing industry profits; (b) with horizontal shareholdings, firms acting in the interests of their shareholders have incentives to constrain output rather than expand; and (c) anticompetitive markets raise returns on capital (which is invested in firms whose product prices are inflated) but also lower the effective returns to labor through (i) higher product prices that lower the purchasing power of wages and (ii) the exercise of monopsony power over labor rates.

Milk expiration dates and clever cartels

A glass of milk Français : Un verre de lait

(Photo credit: Wikipedia)

The Planet Money podcast this week has a story about the Greek economy.  According to the podcast, there is a Greek milk producer “cartel.”  Of course cartels are unlawful in Europe, just as they are in the U.S.  So it seems that Greek milk producers have engineered a clever “cartel” — they have lobbied the Greek government to require that bottled milk have an expiration date no more than 7 days after the milk is obtained from the cow.  As a result, milk produced elsewhere in Europe either isn’t available in Greece or is (I assume) more difficult and more expensive to obtain.

The story is an interesting one, and caused me to pause for a moment about the use of the word “cartel.”  In the U.S., this sort of lobbying would almost certainly be protected by the Noerr-Pennington petitioning immunity.  But what if the milk producers got together and agreed on expiration date rules without obtaining a regulation?

Such an agreement might be a form of a “cartel.”  But it wouldn’t be focused on price — at least not directly.  So it probably wouldn’t be subject to the per se rule.  But I think there’s not much reason to worry about such “cartels,” because they wouldn’t work.  Such a milk “cartel” wouldn’t stop manufacturers outside of Greece from exporting milk to Greece (indeed, it might make longer-shelf-life milk produced outside Greece more attractive to Greek consumers), so Greek manufacturers have little or no incentive to form one.  Only the force of government regulation interferes with distribution of non-Greek milk in Greece.

Could Amazon Possibly Be a Monopolist? (Updated) (Again)

Deutsch: Logo von Amazon.com

(Photo credit: Wikipedia)

Franklin Foer, at the New Republic, argues that the answer is yes.  The alleged “crime”: predatory pricing — if not express, than at least in spirit.

In “There’s one huge problem with calls for anti-trust action against Amazon” at vox.com, Matthew Yglesias rightly points out that market share does not by itself a monopoly make, and further argues that

One important hint about Amazon’s non-monopoly status can be found in its quarterly financial reports. That’s where you find out about a company’s profits. In its most recent quarter, for example, Amazon lost $126 million. Losing money is pretty typical for Amazon, which is not really a profitable company. If you’d like to know more about that, I published 5,000 words on the subject in January. But suffice it to say that “low and often non-existent profits” and “monopoly” are not really concepts that go together.

Competitors hate Amazon because retail was an ultra-competitive low-margin game before Jeff Bezos ever came to town. To delve into this field and make it even more competitive and even lower-margin seems somewhere between unseemly and insane — but it’s the reverse of a monopoly.

Of course, U.S. price predation law can be violated when a firm prices below cost — and loses money — if it is likely to recoup its losses later after its competitors exit the market and it raises prices.  Query whether that is a possibility with online distribution — I don’t know, and am not taking a position for now, but there are certainly reasons to be pretty skeptical — low entry barriers and the like.

Interesting discussion, though.

Update: Paul Krugman says that “Amazon’s Monopsony Is Not O.K.”  But the problems he identifies seem largely theoretical.

Update II: The Wall Street Journal reports that Amazon just reported its biggest operating loss.

Can you ever successfully Daubert an antitrust economist?

English: The iPod family with, from the left t...

The iPod family with, from the left to the right : the shuffle 4G, the nano 6G, the classic 6G and the touch 4G (Photo credit: Wikipedia)

It’s really a very difficult thing to do — and query whether it’s worth the effort.  See, e.g., The Apple iPod iTunes Antitrust Litigation, 2014 U.S. Dist. LEXIS 136437 (N.D. Cal. Sept. 26, 2014) (Gonzalez Rogers, J.) (denying Daubert motions all around).  At least that’s true when the economist is a well-known professor at a major university.

The iPod litigation is, by the way, quite interesting . . . the court has refused to grant Apple summary judgment on the claim that an iTunes update caused consumer lock in.  In an earlier summary judgment order, the court found a triable issue of fact as to whether iTunes update 7.0 was a genuine product improvement so as to not be anticompetitive.

On the Difficulty of Dauberting Antitrust Economists

It’s difficult.  Despite a valiant effort, the defendants in In re: High-Tech Employee Antitrust Litigation, 2014 U.S. Dist. Lexis 47181 (N.D. Cal. Apr. 4, 2014) (Koh, J.), failed to exclude the expert testimony of plaintiffs’ economist, who has opined on the purported wage impact of the defendants’ alleged bilateral agreements not to cold call each other’s employees.

I won’t cover the complex statistics and econometrics here, but if you’re interested, I’m attaching a copy of the decision (click the link).

In re High-Tech Employee Antitrust Litigation

For Those in the Bay Area . . . David D. Friedman, Ph.D. talk on Ronald Coase — January 23

The University of Chicago Logo

The Chicago Economics Society Distinguished Alumni Speaker Series is hosting a talk by David D. Friedman, Professor of Law at Santa Clara University, on Thursday, January 23 at 6:00 pm at the University Club of San Francisco.

Dr. Friedman will discuss the work of the late Ronald Coase, Professor of Economics at the University of Chicago Law School and 1991 recipient of the Nobel Memorial Prize in Economics. Coase advanced legal and economic thought through his own seminal work and as the Editor of the University’s Law and Economics Journal. He is widely regarded as one of the founding scholars of the field of law and economics.

Dr. Friedman’s area of expertise ranges from business to economics to law. He has published economic analyses of punitive damages, trade-secret law, criminal punishment, the size of nations, and a variety of other topics, including medical care, population economics, the economics of war, historical perspectives on freedom, and criminal defense.

The reception begins at 6 pm and is to be followed by the presentation at 6:30 pm.

Cost is $15 per person.

Location is the University Club of San Francisco
800 Powell Street.

Non alums may use this link for ease of registration.  Alums can use this link.

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Market Clearing in the Legal Education Market

According to the Law School Admission Council, the following data represent ABA applicants and applications for each of the past three falls:



The LSAC reports that “[a]s of 08/08/13, there are 385,358 Fall 2013 applications submitted by 59,426 applicants. Applicants are down 12.3% and applications are down 17.9% from 2012.” 

It’s surprising that the figures haven’t gone down further.  That’s probably due to various market imperfections, including incomplete information available to applicants about market conditions.

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On How to Cross-Examine Expert (Economist) Witnesses in an Antitrust Trial

English: W. S. Gilbert's illustration for &quo...

English: W. S. Gilbert’s illustration for “Now, Jurymen, hear my advice” from Gilbert and Sullivan’s Trial by Jury (Photo credit: Wikipedia)

Having recently observed the cross-examination of an expert economist at an antitrust jury trial, I thought I’d note some observations and conclusions.

In antitrust cases, economists play an important, if not critical, role. On the liability side, they help define the relevant markets, and assess whether anticompetitive conduct occurred. On the damages side, they are largely responsible for quantifying damages (or the lack thereof).

Many lawyers deal with expert witnesses, but they are surprised at the detail and extent of antitrust economists’ expert reports. An antitrust economist – supported by many staff members – may spend hundreds or even thousands of hours on a large antitrust case, and may issue 2-4 expert reports, each of which is over 50 pages long. Often these reports relate the operation of complex regression models and are difficult to understand and explain. Lawyers spend many hours helping economists prepare these reports – or working out deposition cross-examination questions to attack them.

Yet, despite all these hours, the complexity of the economic models, and the pages and pages of reports, in a jury trial it all comes down to perhaps 2-3 hours of cross-examination. And because antitrust jury trials happen somewhat infrequently, we don’t often get to see in practice what constitutes an effective cross-examination, and what doesn’t.

Based upon my recent observations, I suggest that the following are not particularly effective approaches:

  • “Death by a thousand (or even a hundred) calculation cuts.” In pages and pages of complex reports, even the best economists are likely to make small arithmetical or mathematical errors. But if these don’t materially affect the economist’s ultimate conclusions, I think the jury is likely to think to itself: “so what; everyone makes little mistakes.” That’s particularly true when the economist is presentable and has a good demeanor. Jurors are smart enough to discount little errors, and can see the forest despite the trees. I’m not saying don’t point out any small errors, but it’s probably not worth the limited time to itemize many of them.
  • Dwelling on small mistakes of fact. Similar to the above point, in the course of preparing a lengthy expert report, an economist is likely to miss some facts in the record, or misunderstand or mischaracterize others. But if they are not large errors, I think the jury is unlikely to care.
  • Trying to get the economist to admit that his/her predictions don’t have a “sufficient” confidence level, that his/her economic model didn’t include several possible predictive variables, etc. Generally speaking, these criticisms are too deep in the weeds. The jury doesn’t care.
  • Getting the economist to agree with many premises without explaining their significance to the jury — as a way to set up your own expert’s direct examination.  I think this approach will likely be unintelligible, at least in large measure.

(I’m assuming here we’re talking about trial. Some of the above points may carry weight at a Daubert hearing.)

So what does work for an effective cross-exam? I suggest the following:

  • Pointing out fundamental mistakes or misapprehensions about record facts. If the economist missed something important, and his or her model therefore does not correspond well to reality, that’s a big deal the jury can and will understand.
  • Pointing out fundamental economic assumptions that have questionable support and that substantially bias an economic model in one direction or another.
  • Personal or professional bias. Usually it doesn’t exist (or at least it is difficult to establish), but if it can be established, it’s jury dynamite.

In short: boil it all down to the absolute fundamentals.  And then boil it down again.

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Are Bar Associations Anti-Competitive?

English: Title page of Adam Smith's Wealth of ...

Title page of Adam Smith’s Wealth of Nations, 1776. (Photo credit: Wikipedia)

From the abstract of a recent paper (via Antitrust & Competition Policy Blog):


The European Commission Report on Competition in Professional Services found that recommended prices by professional bodies have a significant negative effect on competition since they may facilitate the coordination of prices between service providers and/or mislead consumers about reasonable price levels. Professional associations argue, first, that a fee schedule may help their members to properly calculate the cost of services avoiding excessive charges and reducing consumers’ searching costs and, second, that recommended prices are very useful for cost appraisal if a litigant is condemned to pay the legal expenses of the opposing party. Thus, recommended fee schedules could be justified to some extent if they represented the cost of providing the services. We test this hypothesis using cross-section data on a subset of recommended prices by 52 Spanish bar associations and cost data on their territorial jurisdictions. Our empirical results indicate that prices recommended by bar associations are unrelated to the cost of legal services and therefore we conclude that recommended prices have merely an anticompetitive effect.

Aitor Ciarreta (Universidad del Pais Vasco), Maria Paz Espinosa (Universidad del Pais Vasco) and Aitor Zurimendi (Universidad del Pais Vasco), Are Bar Associations Anticompetitive? An Empirical Analysis of Recommended Prices for Legal Services in Spain.  This recalls Adam Smith’s famous statement in The Wealth of Nations: “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.”  Of course, recommended prices — in a vertical distribution situation — are perfectly lawful.  But where a bar association is involved, there are horizontal (or possibly horizontal) aspects to the arrangement.  Cf. Goldfarb v. Virginia State Bar, 421 U.S. 773 (1975) (minimum-fee schedule for lawyers published by the Fairfax County Bar Association not immune from the Sherman Act); Arizona v. Maricopa County Medical Soc., 457 U.S. 332 (1982) (maximum physicians’ fee schedule violated the antitrust laws).


No doubt there is a current oversupply of lawyers.  However, the better way to address concerns about fees is to (lawfully) reduce the supply.  See this blog post, for example.


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Weekend Miscellany: Will Congress Repeal the Antitrust Laws?

I recently stumbled upon this bill (Senate Bill 2269) introduced by Senator Rand Paul a couple months ago.  It is a bill “[t]o permit voluntary economic activity.”  Who isn’t in favor of voluntary economic activity?

The bill is entitled “the Anti-Trust Freedom Act of 2012.”  But the bill probably should be named “A Bill To Repeal the Sherman, Clayton, and FTC Acts as to Individuals.”  Because here is its full text:

The Sherman Act (15 U.S.C. 1 et seq.), the Clayton Act (15 U.S.C. 12 et seq.), and section 5 of the Federal Trade Commission Act (15 U.S.C. 45) shall not be construed to prohibit, ban, or otherwise extend to any voluntary economic coordination, cooperation, agreement, or  other association, compact, contract, or covenant entered into by or between any individual or group of individuals.

I don’t know what motivated the introduction of this bill, nor do I understand why it’s limited to individuals.  (I’d read the bill as not exempting corporations from the antitrust laws — Congress knows how to specify corporations when it wants to.  But what if corporations and individuals conspire together?  Are the corporations subject to antitrust laws, while the individuals are exempt?  Would that make any sense?  Since corporations can act only through individuals, does the bill by indirect implication exempt corporations, too?)

There are interesting and robust debates about whether there is too much, or too little, antitrust enforcement in the U.S.  But this bill goes much further than anything I’ve recently seen (and I for one think it goes much too far).  I suspect it’s not going anywhere, but in today’s difficult economic times, who knows for certain?

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