“The U.S. stock market is having another solid year. You wouldn’t know it by looking at the shares of companies that manage money.”
That’s the lead from Charles Stein on Bloomberg’s Markets’ page today. Stein goes on to offer three possible explanations: 1) a weary bull market, 2) a move toward more active stock-picking by individual investors, and 3) increasing pressure on fees.
So what has any of that to do with the common ownership issue? A few things.
First, it shows that large institutional investors must not be very good at harvesting the benefits of the non-competitive behavior they encourage among the firms the invest in–if you believe they actually do that in the first place. In other words, if you believe common ownership is a problem because CEOs are enriching institutional investors by softening competition, you must admit they’re doing a pretty lousy job of capturing that value.
Second, and more importantly–as well as more relevant–the pressure on fees has led money managers to emphasis low-cost passive index funds. Indeed, among the firms doing well according to the article is BlackRock, “whose iShares exchange-traded fund business tracks indexes, won $20 billion.” In an aggressive move, Fidelity has introduced a total of four zero-fee index funds as a way to draw fee-conscious investors. These index tracking funds are exactly the type of inter-industry diversified funds that negateany incentive for competition softening in any one industry.
Finally, this also illustrates the cost to the investing public of the limits on common ownership proposed by the likes of Einer Elhague, Eric Posner, and Glen Weyl. Were these types of proposals in place, investment managers could not offer diversified index funds that include more than one firm’s stock from any industry with even a moderate level of market concentration. Given competitive forces are pushing investment companies to increase the offerings of such low-cost index funds, any regulatory proposal that precludes those possibilities is sure to harm the investing public.
Just one more piece of real evidence that common ownership is not only not a problem, but that the proposed “fixes” are.
While I’ve not been posting here much in the past few months, Thom and I have written a series of blog posts at Truth On The Market about the perceived problem of common ownership (specifically by institutional investors) across competing firms, and the problems both with the alleged antitrust harms and the proposed “fixes”. Those posts both summarize and expand upon some of the arguments and issues in our paper. To make it easier to find them, I’ve listed them below in chronological–and logical–order:
This issue of common ownership and whether antitrust authorities should deal with it is currently a fairly hot topic. In fact, today the Federal Trade Commission (FTC) is opening up its Hearings on Competition and Consumer Protection in the 21st Century. which include the topic of common ownership. Thom and I submitted comments in advance of the hearing based on our paper. Next week I’ll attend a debate forum on the issue with other scholars (including some aggressive pro-enforcement folks we take to task in our paper), regulators, and members of the investment community. It should be an interesting time.
“Common ownership,” the case of investors owning shares in more than one company–specifically, in shares of companies that compete in the same industry–is currently a hot topic in the antitrust arena. In particular, the alleged effects of common ownership on industry competition are receiving a lot of attention.
Einer Elhague, in the Harvard Law Review, proclaimed “[a]n economic blockbuster has recently been exposed.” Eric Posner, Fiona Scott Morton and Glen Weyl, in the Antitrust Law Journal, assert that “the concentration of markets through large institutional investors is the major new antitrust challenge of our time.” These claims are based on a handful of empirical studies claiming to have identified a causal relationship between the degree of common ownership and such competitive yardsticks as airline prices, banking fees, executive compensation, and even corporate disclosure patterns.
Of course, such a blockbuster antitrust challenge deserves an aggressive policy response, ideas for which both Elhague and Posner, et al., are more than happy to provide.
However, it’s not so clear that the problem is as big as suggested–if it exists at all. It’s also not clear that the proposed policy solutions would make anyone better off (except perhaps antitrust law “experts”)–and could possibly make many people worse off.
If you’re interested, I encourage you to click over to TOTM and read the posts there. Once we’re done, I’ll post a summary and set of links to each of them here. For now, the abstract of our paper is available below:
Recent empirical research purports to demonstrate that institutional investors’ “commonownership” of small stakes in competing firms causes those firms to compete less aggressively, injuring consumers. A number of prominent antitrust scholars have cited this research as grounds for limiting the degree to which institutional investors may hold stakes in multiple firms that compete in any concentrated market. This Article contends that the purported competitive problem is overblown and that the proposed solutions would reduce overall social welfare.
With respect to the purported problem, we show that the theory of anticompetitive harm from institutional investors’ commonownership is implausible and that the empirical studies supporting the theory are methodologically unsound. The theory fails to account for the fact that intra-industry diversified institutional investors are also inter-industry diversified and rests upon unrealistic assumptions about managerial decision-making. The empirical studies purporting to demonstrate anticompetitive harm from commonownership are deficient because they inaccurately assess institutional investors’ economic interests and employ an endogenous measure that precludes causal inferences.
Even if institutional investors’ commonownership of competing firms did soften market competition somewhat, the proposed policy solutions would themselves create welfare losses that would overwhelm any social benefits they secured. The proposed policy solutions would create tremendous new decision costs for business planners and adjudicators and would raise error costs by eliminating welfare-enhancing investment options and/or exacerbating corporate agency costs.
In light of these problems with the purported problem and shortcomings of the proposed solutions, the optimal regulatory approach — at least, on the current empirical record — is to do nothing about institutional investors’ commonownership of small stakes in competing firms.
A few weeks ago I wrote about the Save Local Businesses Act (H.R. 3441), which has passed the U.S. House of Representatives and is currently sitting in the Senate. At the heart of that Act is defining the term “joint employer” for National Labor Relations Board purposes, an issue with tremendous potential implications for the franchising industry, among others. If passed, the Act would codify a long-standing interpretation of franchisees as being the sole employer of their local employees. For reasons I explain in the previous post, that would be a good thing for preserving and facilitating the benefits of franchising.
Franchising is an important business model in the U.S. Franchised local businesses represent the fastest growing segment for employment, and are expected to continue that trend. Franchising obviously offers benefits for both the franchisor and the franchisee.
In a forthcoming paper in Cornell Hospitality Quarterly, Matt Sveum and I find evidence for at least one of the major benefits of franchising. Namely, franchising helps to reduce agency costs and to improve performance incentives at the local establishment level. From the abstract:
A central theme in much of the franchising literature is that franchising mitigates the principle-agent problems between the owner of the franchise company and the operator of the local establishment by making the operator the owner-franchisee of the establishment. Despite the centrality of that assumption in the literature, there is little empirical evidence to support it. We use Census of Retail Trade data for essentially all full- and limited-service restaurants in the US to test whether franchisee ownership affects performance at the establishment level. We find a strong and robust franchise effect for full-service restaurants, but little effect among limited-service restaurants. We argue this difference is consistent with agency costs given differences in work processes and the importance of managerial discretion.
Full citation:
Sveum, Matthew and Sykuta, Michael E., “The Effect of Franchising on Establishment Performance in the U.S. Restaurant Industry,” forthcoming in Cornell Hospitality Quarterly; US Census Bureau Center for Economic Studies Paper No. CES-WP- 16-54. Available at SSRN: https://ssrn.com/abstract=2883267 or http://dx.doi.org/10.2139/ssrn.2883267
No, I’m not referring to the hit 1980s sitcom that launched Alyssa Milano’s career and took Tony Danza from a dimwitted, cab-driving boxer (in Taxi) to lovable hunky housekeeper. It’s a more important question than that.
Who’s the boss at a local business? Especially if that business has close relationships with another, larger company?
That’s the question at the heart of the Save Local Business Act (H.R. 3441) that is currently waiting action in the U.S. Senate. And how that question is answered could have big implications for hundreds of thousands of small business owners. For starters, and perhaps most specifically, for every locally owned franchised business in the United States. But that’s not all.
The issue stems from a 2014 National Labor Relations Board (NLRB) ruling in which the Board voted 3-2 to find that McDonald’s Corp. was a “joint employer” with all of their franchisees. In that case, labor union activists filed a complaint against McDonald’s directly rather than having to work against multiple individual franchisees, claiming that because McDonald’s Corp provides training and recommends employment standards and work policies for the local business owners that use the McDonald’s brand, the franchisor is effectively a joint-employer. And therefore, any labor violations that can be levied against one joint-employer apply to the local business as a whole. The NLRB agreed.
Prior to this ruling, the NLRB treated local franchisee owners as the sole employer of the local business. That meant that any labor complaints had to be filed against each individual franchisee. By expanding its definition of joint-employer, the NLRB made it easier for labor groups to a) file complaints against and b) potentially unionize an entire franchise network.
two or more entities are joint employers of a single workforce if (1) they are both employers within the meaning of the common law; and (2) they share or codetermine those matters governing the essential terms and conditions of employment.
This is not just an issue for franchises (indeed, Browing-Ferris was not about a franchise case). In fact, the above definition could be read to mean that any company that hires another company to provide services could be considered a joint employer of the contracted company’ employees, even if only on a temporary basis as part of their otherwise full-time job. That includes anything from temp agencies to security companies to housekeeping or maintenance contractors; even to agricultural producers.
For instance, many farmers raise chickens or hogs under contract with a meat processing company. Those companies may require the farmer and any farm employees to follow certain routines or practices to ensure the health and well-being of the animals being raised. Under Browning-Ferris, one could argue the processor is a joint-employer with the farmer, making the farmer subject to a host of employment laws that typically do not apply to small businesses.
Local business owners breaking ground for their new franchised store, the first Sonic restaurant in Rhode Island.
Likewise with franchisees, whether owners of restaurants, hotels, tax preparation companies, cleaning companies, home healthcare companies, or retail outlets. Most franchisees are small, local business owners that pay the franchisor for the rights to use the franchisor’s brand name and business format, to gain access to training resources, and perhaps to access inventories and supplies. Because the franchisor provides training resources and may recommend things like staffing levels, training processes, etc., as part of their business plan (which is one of the reasons to buy the franchise in the first place), most franchisors could be deemed joint employers with their local business owner franchisees.
That creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. Moreover, it puts any franchisee at even greater risk for the behavior of other franchisees and their employees. And that is a powerful disincentive for franchising. Since franchised businesses have been the fastest growing sector of the economy, such regulations could have far-reaching implications.
Joint employer status creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. And that is a powerful disincentive for franchising.
Fortunately for now, a new presidential administration in 2017 led to a change in the composition of the National Labor Relations Board. The new NLRB board voted 3-2 to overturn Browning-Ferris and restore its previous definition of joint employer.
And therein lies part of the problem. Change presidents, change NLRB composition, change the rules. That is what the Save Local Business Act is intended to fix. The Act provides a legislative solution to the problem of agency (NLRB)) discretion in defining what constitutes a joint employer. Can laws change? Yes. But that requires more than a change of one person (as in the case of the NLRB) to change the law.
So who’s the boss? For now, it’s the local business owner. It’s up to Congress to remove the uncertainty about how that question will be answered in years to come.
Seems the State of New York is going to the Supreme Court for another of its protectionist regulatory policies. Yesterday the US Supreme Court granted a petition to hear the case of Expressions Hair Design v. Schneiderman. As the WSJ explains, at issue is whether New York’s regulations concerning credit-versus-cash retail prices constitute a First Amendment speech violation.
The problem stems from the fact that the State of New York has attempted to have its cake and eat it to by ignoring economic realism and prohibiting retailers from calling a cost a cost. The State prohibits retailers from charging customers a fee for using a credit card, but allows retailers to give customers a discount if they use cash. A group of hair salons, led by Expressions Hair Design, sued the state for infringing on its right of free commercial speech. The salons won their initial case, which was reversed on appeal. Now SCOTUS will have an opportunity to weigh in.
The Cost of Using Credit
From an economic perspective, the issue is fairly simple. Credit card companies charge vendors a fee every time a consumer pays with plastic. How much depends on the credit card company, whether the transaction is run as debit or credit, and the amount of the transaction. But typically, the fee is around 2-4% of the amount of the purchase. This reduces the amount of revenue retailers receive when the customer uses plastic. Put another way, when customers choose to use plastic, it raises the retailer’s cost of doing business for that sale.
In a free economy, retailers could choose one of three options: 1) force the credit card user to pay the additional transaction fee, which raises the price at the point of sale, 2) charge the same price for all buyers, implicitly charging cash users more for the product to subsidize the costs of the plastic users, or 3) pass the transaction fee savings on to cash users by giving them a discount. The only economic difference between 1 and 3 is what the sticker price is relative to the price actually paid. In #1, credit card users pay more than the sticker price; in #3, cash users pay less than the sticker price. In #1, the credit card fee is made explicit by adding it on just for those consumers who use plastic. In #3, the sticker price includes (i.e., hides) the cost of using a credit card and by default is the price everyone pays unless they are aware of the cash discount. In either case (1 or 3), the retailer is price discriminating between cash and plastic users. Or the retailer could simply post two sets of prices, one for credit and one for cash, which would then beg the question of “why the difference?” And that is where the NY regulations become a problem.
The NY regulation prohibits retailers from choosing #1 but allows them to choose #3. In other words, the regulation allows retailers to price discriminate, but only if they present it as a discount for cash users rather than a surcharge for credit card users. In short, NY allows the exact same price discrimination between two sets of consumers, but restricts the speech of retailers in how they are allowed to describe that price difference. As Expressions Hair Design argues in their complaint, this places a burden on the business in how it is allowed to explain or justify what is otherwise a perfectly legal two-price pricing system since the regulations make it illegal for employees to explain that the difference between the cash price and the credit price is due to the cost of the credit transaction. It would be like passing a law prohibiting a restaurant from explaining the cost of its steaks went up relative to its pork chops because the price of beef rose.
Framing matters
Why would the State of New York prohibit credit card surcharges but not prohibit cash discounts? Consumers respond to price signals, so how those signals are presented matters. If consumers are charged an extra fee for using their credit card, it makes the cost (price) of using the credit card very obvious to the consumer and she is more likely to change her behavior by using cash instead. This would be bad for the banks that make a significant amount of money on credit card swipe fees. Not surprisingly, banks support laws prohibiting explicit credit card surcharges. However, as noted in #2 above, charging cash and plastic users the same forces cash users to subsidize the purchases of plastic users, which also tends to penalize lower income persons relative to wealthier shoppers. So allowing retailers the opportunity to provide cash discounts is socially superior to not allowing differential pricing. However, the NY’s prohibition on calling a cost a cost and explaining the price difference for what it is, is not only an infringement on speech, but unjustifiable as anything other than an attempt to mislead consumers and protect credit card issuers.
11th Annual Conference on Empirical Legal Studies (CELS)
Duke Law School, Durham, North Carolina
Friday, November 18 and Saturday, November 19, 2016
Duke Law School is pleased to host the 11th Annual Conference on Empirical Legal Studies (CELS) on November 18-19, 2016. CELS is a highly regarded interdisciplinary gathering that draws scholars from across the country and internationally and is sponsored by the Society for Empirical Legal Studies. The conference brings together hundreds of scholars from law, economics, political science, psychology, policy analysis, and other fields who are interested in the empirical analysis of law and legal institutions. Papers are selected through a peer review process and discussion at the conference includes assigned commentators and audience questions.
o’s the boss at a local business? Especially if that business has close relationships with another, larger company?
whole. The NLRB agreed.
