The current debate on the competitive risks of common ownership has focused on whether index investments soften competition among portfolio companies. However, even if one concedes, in arguendo, that this is the case, it remains unclear in what way this bears on the analysis of horizontal mergers between portfolio companies. The EU Commission in Dow/DuPont (Case M.7932) and Bayer/Monsanto (Case M.8084) has alleged that common ownership is ‘an element of context in the appreciation of any significant impediment to effective competition’. Additionally, the Commission is of the view that impediments resulting from common ownership are not confined to price effects but can also relate to innovation competition.
In our study in two recent papers, ‘Common Ownership and Mergers Between Portfolio Companies’, and ‘Price Pressure Indices, Innovation and Mergers Between Commonly Owned Firms’ we analyze whether the mere prevalence of common ownership in a market qualifies as a plus-factor that intensifies post-merger unilateral effects resulting from mergers between portfolio companies without more.
We merely assume, for the sake of argumentation, that common ownership gives a portfolio company’s management incentives to consider the effect of their own pricing decisions on their rivals’ profits. Such is sometimes suggested in articles by lawyers and economists—eg ‘How Horizontal Shareholding Harms Our Economy—And Why Antitrust Law Can Fix It’, by Einer Elhauge, ‘A Proposal to Limit the Anti-Competitive Power of Institutional Investors’, by Eric A Posner, Fiona M Scott Morton and E Glen Weyl, and ‘Anti-Competitive Effects of Common Ownership’, by José Azar, Martin C Schmalz and Isabel Tecu.
Our main hypothesis is that it would nonetheless be unconvincing to assume that the mere prevalence of common ownership in a market increases the unilateral effects that result from a horizontal merger between portfolio companies. Instead, we posit that this depends on the facts of the case. The existence of common ownership might even mitigate post-merger unilateral effects if compared to the counterfactual absent the merger.
Our first observation is that pricing indices, such as Upward Pricing Pressure (UPP) and the Gross Upward Pricing Pressure Index (GUPPI), must be applied with care when common ownership is pervasive. These indices concern only ‘marginal’ adjustments and therefore focus on partial price-increasing incentives. The prices of all other firms, including that of the other merging party, are held constant. In an environment of common ownership, however, the merger can create an ownership link to a non-merging firm if the latter company shares at least one common owner with one of the merging parties. Consequently, the incentives of the merged entity will now, under common ownership, potentially incorporate also the margins and profits of such an outsider. Therefore, the information provided by UPP and GUPPI analysis on the likelihood of post-merger price increases can be less robust than absent common ownership.
The main part of our analysis then gravitates to the questions to what extent any given firm internalizes rivals’ profits before and after the merger, which we refer to as ‘incremental internalization’, and how this difference is shaped by the presence of common ownership.
If the merger largely keeps the set of common owners of the merged entity unchanged, pre-merger common ownership tends to mitigate the effects of a merger. That is since the merging parties have already before the merger internalized pricing externalities to a certain extent. The additional unilateral upward pricing incentive coming from the horizontal merger is therefore likely smaller than in a counterfactual in which common ownership does not exist. If, however, the merger extends the web of common ownership through which the merged entity is linked to rivals after the merger, common ownership tends to increase unilateral effects arising from the merger. Widening the common ownership matrix adds to the extent to which the merged entity will internalize pricing externalities after the merger.
We then map these conclusions onto innovation competition. The basic principles developed with respect to price competition can be applied here, as far as innovation has a business stealing effect. Yet the effects of common ownership can yield inverse results if innovation in a competitive market is characterized by spillovers. An increase in post-merger internalization through the effects of common ownership can then increase incentives for innovation if compared to the pre-merger counterfactual. This is an emanation of the merger efficiency of ‘appropriability’.
In conclusion, we find that the allegations made with respect to the competitive harmfulness of common ownership cannot serve as a circumstantial factor for merger assessment without evaluation of the actual effects on price, innovation competition or other competitive parameters. Any theory of harm based on common ownership in real cases therefore requires evidence on how the merger will alter the determinants for internalization to the worse.
Roman Inderst is a Professor and holds the Chair of Finance and Economics at Goethe-University, Frankfurt, Germany.
Stefan Thomas is a Professor and holds the Chair of Civil, Commercial and Competition Law at the University of Tübingen, Germany.