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Last week, the DOJ cleared the merger of CVS Health and Aetna (conditional on Aetna’s divesting its Medicare Part D business), a merger that, as I previously noted at a House Judiciary hearing, “presents a creative effort by two of the most well-informed and successful industry participants to try something new to reform a troubled system.” (My full testimony is available here).

Of course it’s always possible that the experiment will fail — that the merger won’t “revolutioniz[e] the consumer health care experience” in the way that CVS and Aetna are hoping. But it’s a low (antitrust) risk effort to address some of the challenges confronting the healthcare industry — and apparently the DOJ agrees.

I discuss the weakness of the antitrust arguments against the merger at length in my testimony. What I particularly want to draw attention to here is how this merger — like many vertical mergers — represents business model innovation by incumbents.

The CVS/Aetna merger is just one part of a growing private-sector movement in the healthcare industry to adopt new (mostly) vertical arrangements that seek to move beyond some of the structural inefficiencies that have plagued healthcare in the United States since World War II. Indeed, ambitious and interesting as it is, the merger arises amidst a veritable wave of innovative, vertical healthcare mergers and other efforts to integrate the healthcare services supply chain in novel ways.

These sorts of efforts (and the current DOJ’s apparent support for them) should be applauded and encouraged. I need not rehash the economic literature on vertical restraints here (see, e.g., Lafontaine & Slade, etc.). But especially where government interventions have already impaired the efficient workings of a market (as they surely have, in spades, in healthcare), it is important not to compound the error by trying to micromanage private efforts to restructure around those constraints.   

Current trends in private-sector-driven healthcare reform

In the past, the most significant healthcare industry mergers have largely been horizontal (i.e., between two insurance providers, or two hospitals) or “traditional” business model mergers for the industry (i.e., vertical mergers aimed at building out managed care organizations). This pattern suggests a sort of fealty to the status quo, with insurers interested primarily in expanding their insurance business or providers interested in expanding their capacity to provide medical services.

Today’s health industry mergers and ventures seem more frequently to be different in character, and they portend an industry-wide experiment in the provision of vertically integrated healthcare that we should enthusiastically welcome.

Drug pricing and distribution innovations

To begin with, the CVS/Aetna deal, along with the also recently approved Cigna-Express Scripts deal, solidifies the vertical integration of pharmacy benefit managers (PBMs) with insurers.

But a number of other recent arrangements and business models center around relationships among drug manufacturers, pharmacies, and PBMs, and these tend to minimize the role of insurers. While not a “vertical” arrangement, per se, Walmart’s generic drug program, for example, offers $4 prescriptions to customers regardless of insurance (the typical generic drug copay for patients covered by employer-provided health insurance is $11), and Walmart does not seek or receive reimbursement from health plans for these drugs. It’s been offering this program since 2006, but in 2016 it entered into a joint buying arrangement with McKesson, a pharmaceutical wholesaler (itself vertically integrated with Rexall pharmacies), to negotiate lower prices. The idea, presumably, is that Walmart will entice consumers to its stores with the lure of low-priced generic prescriptions in the hope that they will buy other items while they’re there. That prospect presumably makes it worthwhile to route around insurers and PBMs, and their reimbursements.

Meanwhile, both Express Scripts and CVS Health (two of the country’s largest PBMs) have made moves toward direct-to-consumer sales themselves, establishing pricing for a small number of drugs independently of health plans and often in partnership with drug makers directly.   

Also apparently focused on disrupting traditional drug distribution arrangements, Amazon has recently purchased online pharmacy PillPack (out from under Walmart, as it happens), and with it received pharmacy licenses in 49 states. The move introduces a significant new integrated distributor/retailer, and puts competitive pressure on other retailers and distributors and potentially insurers and PBMs, as well.

Whatever its role in driving the CVS/Aetna merger (and I believe it is smaller than many reports like to suggest), Amazon’s moves in this area demonstrate the fluid nature of the market, and the opportunities for a wide range of firms to create efficiencies in the market and to lower prices.

At the same time, the differences between Amazon and CVS/Aetna highlight the scope of product and service differentiation that should contribute to the ongoing competitiveness of these markets following mergers like this one.

While Amazon inarguably excels at logistics and the routinizing of “back office” functions, it seems unlikely for the foreseeable future to be able to offer (or to be interested in offering) a patient interface that can rival the service offerings of a brick-and-mortar CVS pharmacy combined with an outpatient clinic and its staff and bolstered by the capabilities of an insurer like Aetna. To be sure, online sales and fulfillment may put price pressure on important, largely mechanical functions, but, like much technology, it is first and foremost a complement to services offered by humans, rather than a substitute. (In this regard it is worth noting that McKesson has long been offering Amazon-like logistics support for both online and brick-and-mortar pharmacies. “‘To some extent, we were Amazon before it was cool to be Amazon,’ McKesson CEO John Hammergren said” on a recent earnings call).

Treatment innovations

Other efforts focus on integrating insurance and treatment functions or on bringing together other, disparate pieces of the healthcare industry in interesting ways — all seemingly aimed at finding innovative, private solutions to solve some of the costly complexities that plague the healthcare market.

Walmart, for example, announced a deal with Quest Diagnostics last year to experiment with offering diagnostic testing services and potentially other basic healthcare services inside of some Walmart stores. While such an arrangement may simply be a means of making doctor-prescribed diagnostic tests more convenient, it may also suggest an effort to expand the availability of direct-to-consumer (patient-initiated) testing (currently offered by Quest in Missouri and Colorado) in states that allow it. A partnership with Walmart to market and oversee such services has the potential to dramatically expand their use.

Capping off (for now) a buying frenzy in recent years that included the purchase of PBM, CatamaranRx, UnitedHealth is seeking approval from the FTC for the proposed merger of its Optum unit with the DaVita Medical Group — a move that would significantly expand UnitedHealth’s ability to offer medical services (including urgent care, outpatient surgeries, and health clinic services), give it a significant group of doctors’ clinics throughout the U.S., and turn UnitedHealth into the largest employer of doctors in the country. But of course this isn’t a traditional managed care merger — it represents a significant bet on the decentralized, ambulatory care model that has been slowly replacing significant parts of the traditional, hospital-centric care model for some time now.

And, perhaps most interestingly, some recent moves are bringing together drug manufacturers and diagnostic and care providers in innovative ways. Swiss pharmaceutical company, Roche, announced recently that “it would buy the rest of U.S. cancer data company Flatiron Health for $1.9 billion to speed development of cancer medicines and support its efforts to price them based on how well they work.” Not only is the deal intended to improve Roche’s drug development process by integrating patient data, it is also aimed at accommodating efforts to shift the pricing of drugs, like the pricing of medical services generally, toward an outcome-based model.

Similarly interesting, and in a related vein, early this year a group of hospital systems including Intermountain Health, Ascension, and Trinity Health announced plans to begin manufacturing generic prescription drugs. This development further reflects the perceived benefits of vertical integration in healthcare markets, and the move toward creative solutions to the unique complexity of coordinating the many interrelated layers of healthcare provision. In this case,

[t]he nascent venture proposes a private solution to ensure contestability in the generic drug market and consequently overcome the failures of contracting [in the supply and distribution of generics]…. The nascent venture, however it solves these challenges and resolves other choices, will have important implications for the prices and availability of generic drugs in the US.

More enforcement decisions like CVS/Aetna and Bayer/Monsanto; fewer like AT&T/Time Warner

In the face of all this disruption, it’s difficult to credit anticompetitive fears like those expressed by the AMA in opposing the CVS-Aetna merger and a recent CEA report on pharmaceutical pricing, both of which are premised on the assumption that drug distribution is unavoidably dominated by a few PBMs in a well-defined, highly concentrated market. Creative arrangements like the CVS-Aetna merger and the initiatives described above (among a host of others) indicate an ease of entry, the fluidity of traditional markets, and a degree of business model innovation that suggest a great deal more competitiveness than static PBM market numbers would suggest.

This kind of incumbent innovation through vertical restructuring is an increasingly important theme in antitrust, and efforts to tar such transactions with purported evidence of static market dominance is simply misguided.

While the current DOJ’s misguided (and, remarkably, continuing) attempt to stop the AT&T/Time Warner merger is an aberrant step in the wrong direction, the leadership at the Antitrust Division generally seems to get it. Indeed, in spite of strident calls for stepped-up enforcement in the always-controversial ag-biotech industry, the DOJ recently approved three vertical ag-biotech mergers in fairly rapid succession.

As I noted in a discussion of those ag-biotech mergers, but equally applicable here, regulatory humility should continue to carry the day when it comes to structural innovation by incumbent firms:

But it is also important to remember that innovation comes from within incumbent firms, as well, and, often, that the overall level of innovation in an industry may be increased by the presence of large firms with economies of scope and scale.

In sum, and to paraphrase Olympia Dukakis’ character in Moonstruck: “what [we] don’t know about [the relationship between innovation and market structure] is a lot.”

What we do know, however, is that superficial, concentration-based approaches to antitrust analysis will likely overweight presumed foreclosure effects and underweight innovation effects.

We shouldn’t fetishize entry, or access, or head-to-head competition over innovation, especially where consumer welfare may be significantly improved by a reduction in the former in order to get more of the latter.

regulation-v41n3-coverCalm Down about Common Ownership” is the title of a piece Thom Lambert and I published in the Fall 2018 issue of Regulation, which just hit online. The article is a condensed version our recent paper, “The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms.” In short, we argue that concern about common ownership lacks a theoretically sound foundation and is built upon faulty empirical support. We also explain why proposed “fixes” would do more harm than good.

Over the past several weeks we wrote a series of blog posts here that summarize or expand upon different parts of our argument. To pull them all into one place:

At the heart of the common ownership issue in the current antitrust debate is an empirical measure, the Modified Herfindahl-Hirschmann Index, researchers have used to correlate patterns of common ownership with measures of firm behavior and performance. In an accompanying post, Thom Lambert provides a great summary of just what the MHHI, and more specifically the MHHIΔ, is and how it can be calculated. I’m going to free-ride off Thom’s effort, so if you’re not very familiar with the measure, I suggest you start here and here.

There are multiple problems with the common ownership story and with the empirical evidence proponents of stricter antitrust enforcement point to in order to justify their calls to action. Thom and I address a number of those problems in our recent paper on “The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms.” However, one problem we don’t take on in that paper is the nature of the MHHIΔ itself. More specifically, what is one to make of it and how should it be interpreted, especially from a policy perspective?

The Policy Benchmark

The benchmark for discussion is the original Herfindahl-Hirschmann Index (HHI), which has been part of antitrust for decades. The HHI is calculated by summing the squared value of each firm’s market share. Depending on whether you use percents or percentages, the value of the sum may be multiplied by 10,000. For instance, for two firms that split the market evenly, the HHI could be calculated either as:

HHI = 502 + 502 = 5.000, or
HHI = (.502 + .502)*10,000 = 5,000

It’s a pretty simple exercise to see that one of the useful properties of HHI is that it is naturally bounded between 0 and 10,000. In the case of a pure monopoly that commands the entire market, the value of HHI is 10,000 (1002). As the number of firms increases and market shares approach very small fractions, the value of HHI asymptotically approaches 0. For a market with 10 firms firms that evenly share the market, for instance, HHI is 1,000; for 100 identical firms, HHI is 100; for 1,000 identical firms, HHI is 1. As a result, we know that when HHI is close to 10,000, the industry is highly concentrated in one firm; and when the HHI is close to zero, there is no meaningful concentration at all. Indeed, the Department of Justice’s Horizontal Merger Guidelines make use of this property of the HHI:

Based on their experience, the Agencies generally classify markets into three types:

  • Unconcentrated Markets: HHI below 1500
  • Moderately Concentrated Markets: HHI between 1500 and 2500
  • Highly Concentrated Markets: HHI above 2500

The Agencies employ the following general standards for the relevant markets they have defined:

  • Small Change in Concentration: Mergers involving an increase in the HHI of less than 100 points are unlikely to have adverse competitive effects and ordinarily require no further analysis.
  • Unconcentrated Markets: Mergers resulting in unconcentrated markets are unlikely to have adverse competitive effects and ordinarily require no further analysis.
  • Moderately Concentrated Markets: Mergers resulting in moderately concentrated markets that involve an increase in the HHI of more than 100 points potentially raise significant competitive concerns and often warrant scrutiny.
  • Highly Concentrated Markets: Mergers resulting in highly concentrated markets that involve an increase in the HHI of between 100 points and 200 points potentially raise significant competitive concerns and often warrant scrutiny. Mergers resulting in highly concentrated markets that involve an increase in the HHI of more than 200 points will be presumed to be likely to enhance market power. The presumption may be rebutted by persuasive evidence showing that the merger is unlikely to enhance market power.

Just by way of reference, an HHI of 2500 could reflect four firms sharing the market equally (i.e., 25% each), or it could be one firm with roughly 49% of the market and 51 identical small firms sharing the rest evenly.

Injecting MHHIΔ Into the Mix

MHHI is intended to account for both the product market concentration among firms captured by the HHI, and the common ownership concentration across firms in the market measured by the MHHIΔ. In short, MHHI = HHI + MHHIΔ.

As Thom explains in great detail, MHHIΔ attempts to measure the combined effects of the relative influence of shareholders that own positions across competing firms on management’s strategic decision-making and the combined market shares of the commonly-owned firms. MHHIΔ is the measure used in the various empirical studies allegedly demonstrating a causal relationship between common ownership (higher MHHIΔs) and the supposed anti-competitive behavior of choice.

Some common ownership critics, such as Einer Elhague, have taken those results and suggested modifying antitrust rules to incorporate the MHHIΔ in the HHI guidelines above. For instance, Elhague writes (p 1303):

Accordingly, the federal agencies can and should challenge any stock acquisitions that have produced, or are likely to produce, anti-competitive horizontal shareholdings. Given their own guidelines and the empirical results summarized in Part I, they should investigate any horizontal stock acquisitions that have created, or would create, a ΔMHHI of over 200 in a market with an MHHI over 2500, in order to determine whether those horizontal stock acquisitions raised prices or are likely to do so.

Elhague, like many others, couch their discussion of MHHI and MHHIΔ in the context of HHI values as though the additive nature of MHHI means such a context make sense. And if the examples are carefully chosen, the numbers even seem to make sense. For instance, even in our paper (page 30), we give a few examples to illustrate some of the endogeneity problems with MHHIΔ:

For example, suppose again that five institutional investors hold equal stakes (say, 3%) of each airline servicing a market and that the airlines have no other significant shareholders.  If there are two airlines servicing the market and their market shares are equivalent, HHI will be 5000, MHHI∆ will be 5000, and MHHI (HHI + MHHI∆) will be 10000.  If a third airline enters and grows so that the three airlines have equal market shares, HHI will drop to 3333, MHHI∆ will rise to 6667, and MHHI will remain constant at 10000.  If a fourth airline enters and the airlines split the market evenly, HHI will fall to 2500, MHHI∆ will rise further to 7500, and MHHI will again total 10000.

But do MHHI and MHHI∆ really fit so neatly into the HHI framework? Sadly–and worringly–no, not at all.

The Policy Problem

There seems to be a significant problem with simply imposing MHHIΔ into the HHI framework. Unlike HHI, from which we can infer something about the market based on the nominal value of the measure, MHHIΔ has no established intuitive or theoretical grounding. In fact, MHHIΔ has no intuitively meaningful mathematical boundaries from which to draw inferences about “how big is big?”, a fundamental problem for antitrust policy.

This is especially true within the range of cross-shareholding values we’re talking about in the common ownership debate. To illustrate just how big a problem this is, consider a constrained optimization of MHHI based on parameters that are not at all unreasonable relative to hypothetical examples cited in the literature:

  • Four competing firms in the market, each of which is constrained to having at least 5% market share, and their collective sum must equal 1 (or 100%).
  • Five institutional investors each of which can own no more than 5% of the outstanding shares of any individual airline, with no restrictions across airlines.
  • The remaining outstanding shares are assumed to be diffusely owned (i.e., no other large shareholder in any firm).

With only these modest restrictions on market share and common ownership, what’s the maximum potential value of MHHI? A mere 26,864,516,491, with an MHHI∆ of 26,864,513,774 and HHI of 2,717.

That’s right, over 26.8 billion. To reach such an astronomical number, what are the parameter values? The four firms split the market with 33, 31.7, 18.3, and 17% shares, respectively. Investor 1 owns 2.6% of the largest firm (by market share) while Investors 2-5 each own between 4.5 and 5% of the largest firm. Investors 1 and 2 own 5% of the smallest firm, while Investors 3 and 4 own 3.9% and Investor 5 owns a minuscule (0.0006%) share. Investor 2 is the only investor with any holdings (a tiny 0.0000004% each) in the two middling firms. These are not unreasonable numbers by any means, but the MHHI∆ surely is–especially from a policy perspective.

So if MHHI∆ can range from near zero to as much as 28.6 billion within reasonable ranges of market share and shareholdings, what should we make of Elhague’s proposal that mergers be scrutinized for increasing MHHI∆ by 200 points if the MHHI is 2,500 or more? We argue that such an arbitrary policy model is not only unfounded empirically, but is completely void of substantive reason or relevance.

The DOJ’s Horizontal Merger Guidelines above indicate that antitrust agencies adopted the HHI benchmarks for review “[b]ased on their experience”.  In the 1982 and 1984 Guidelines, the agencies adopted HHI standards 1,000 and 1,800, compared to the current 1,500 and 2,500 levels, in determining whether the industry is concentrated and a merger deserves additional scrutiny. These changes reflect decades of case reviews relating market structure to likely competitive behavior and consumer harm.

We simply do not know enough yet empirically about the relation between MHHI∆ and benchmarks of competitive behavior and consumer welfare to make any intelligent policies based on that metric–even if the underlying argument had any substantive theoretical basis, which we doubt. This is just one more reason we believe the best response to the common ownership problem is to do nothing, at least until we have a theoretically, and empirically, sound basis on which to make intelligent and informed policy decisions and frameworks.

As Thom previously posted, he and I have a new paper explaining The Case for Doing Nothing About Common Ownership of Small Stakes in Competing Firms. Our paper is a response to cries from the likes of Einer Elhauge and of Eric Posner, Fiona Scott Morton, and Glen Weyl, who have called for various types of antitrust action to reign in what they claim is an “economic blockbuster” and “the major new antitrust challenge of our time,” respectively. This is the first in a series of posts that will unpack some of the issues and arguments we raise in our paper.

At issue is the growth in the incidence of common-ownership across firms within various industries. In particular, institutional investors with broad portfolios frequently report owning small stakes in a number of firms within a given industry. Although small, these stakes may still represent large block holdings relative to other investors. This intra-industry diversification, critics claim, changes the managerial objectives of corporate executives from aggressively competing to increase their own firm’s profits to tacitly colluding to increase industry-level profits instead. The reason for this change is that competition by one firm comes at a cost of profits from other firms in the industry. If investors own shares across firms, then any competitive gains in one firm’s stock are offset by competitive losses in the stocks of other firms in the investor’s portfolio. If one assumes corporate executives aim to maximize total value for their largest shareholders, then managers would have incentive to soften competition against firms with which they share common ownership. Or so the story goes (more on that in a later post.)

Elhague and Posner, et al., draw their motivation for new antitrust offenses from a handful of papers that purport to establish an empirical link between the degree of common ownership among competing firms and various measures of softened competitive behavior, including airline prices, banking fees, executive compensation, and even corporate disclosure patterns. The paper of most note, by José Azar, Martin Schmalz, and Isabel Tecu and forthcoming in the Journal of Finance, claims to identify a causal link between the degree of common ownership among airlines competing on a given route and the fares charged for flights on that route.

Measuring common ownership with MHHI

Azar, et al.’s airline paper uses a metric of industry concentration called a Modified Herfindahl–Hirschman Index, or MHHI, to measure the degree of industry concentration taking into account the cross-ownership of investors’ stakes in competing firms. The original Herfindahl–Hirschman Index (HHI) has long been used as a measure of industry concentration, debuting in the Department of Justice’s Horizontal Merger Guidelines in 1982. The HHI is calculated by squaring the market share of each firm in the industry and summing the resulting numbers.

The MHHI is rather more complicated. MHHI is composed of two parts: the HHI measuring product market concentration and the MHHI_Delta measuring the additional concentration due to common ownership. We offer a step-by-step description of the calculations and their economic rationale in an appendix to our paper. For this post, I’ll try to distill that down. The MHHI_Delta essentially has three components, each of which is measured relative to every possible competitive pairing in the market as follows:

  1. A measure of the degree of common ownership between Company A and Company -A (Not A). This is calculated by multiplying the percentage of Company A shares owned by each Investor I with the percentage of shares Investor I owns in Company -A, then summing those values across all investors in Company A. As this value increases, MHHI_Delta goes up.
  2. A measure of the degree of ownership concentration in Company A, calculated by squaring the percentage of shares owned by each Investor I and summing those numbers across investors. As this value increases, MHHI_Delta goes down.
  3. A measure of the degree of product market power exerted by Company A and Company -A, calculated by multiplying the market shares of the two firms. As this value increases, MHHI_Delta goes up.

This process is repeated and aggregated first for every pairing of Company A and each competing Company -A, then repeated again for every other company in the market relative to its competitors (e.g., Companies B and -B, Companies C and -C, etc.). Mathematically, MHHI_Delta takes the form:

where the Ss represent the firm market shares of, and Betas represent ownership shares of Investor I in, the respective companies A and -A.

As the relative concentration of cross-owning investors to all investors in Company A increases (i.e., the ratio on the right increases), managers are assumed to be more likely to soften competition with that competitor. As those two firms control more of the market, managers’ ability to tacitly collude and increase joint profits is assumed to be higher. Consequently, the empirical research assumes that as MHHI_Delta increases, we should observe less competitive behavior.

And indeed that is the “blockbuster” evidence giving rise to Elhauge’s and Posner, et al.,’s arguments  For example, Azar, et. al., calculate HHI and MHHI_Delta for every US airline market–defined either as city-pairs or departure-destination pairs–for each quarter of the 14-year time period in their study. They then regress ticket prices for each route against the HHI and the MHHI_Delta for that route, controlling for a number of other potential factors. They find that airfare prices are 3% to 7% higher due to common ownership. Other papers using the same or similar measures of common ownership concentration have likewise identified positive correlations between MHHI_Delta and their respective measures of anti-competitive behavior.

Problems with the problem and with the measure

We argue that both the theoretical argument underlying the empirical research and the empirical research itself suffer from some serious flaws. On the theoretical side, we have two concerns. First, we argue that there is a tremendous leap of faith (if not logic) in the idea that corporate executives would forgo their own self-interest and the interests of the vast majority of shareholders and soften competition simply because a small number of small stakeholders are intra-industry diversified. Second, we argue that even if managers were so inclined, it clearly is not the case that softening competition would necessarily be desirable for institutional investors that are both intra- and inter-industry diversified, since supra-competitive pricing to increase profits in one industry would decrease profits in related industries that may also be in the investors’ portfolios.

On the empirical side, we have concerns both with the data used to calculate the MHHI_Deltas and with the nature of the MHHI_Delta itself. First, the data on institutional investors’ holdings are taken from Schedule 13 filings, which report aggregate holdings across all the institutional investor’s funds. Using these data masks the actual incentives of the institutional investors with respect to investments in any individual company or industry. Second, the construction of the MHHI_Delta suffers from serious endogeneity concerns, both in investors’ shareholdings and in market shares. Finally, the MHHI_Delta, while seemingly intuitive, is an empirical unknown. While HHI is theoretically bounded in a way that lends to interpretation of its calculated value, the same is not true for MHHI_Delta. This makes any inference or policy based on nominal values of MHHI_Delta completely arbitrary at best.

We’ll expand on each of these concerns in upcoming posts. We will then take on the problems with the policy proposals being offered in response to the common ownership ‘problem.’

 

 

 

 

 

 

One of the hottest antitrust topics of late has been institutional investors’ “common ownership” of minority stakes in competing firms.  Writing in the Harvard Law Review, Einer Elhauge proclaimed that “[a]n economic blockbuster has recently been exposed”—namely, “[a] small group of institutions has acquired large shareholdings in horizontal competitors throughout our economy, causing them to compete less vigorously with each other.”  In the Antitrust Law Journal, Eric Posner, Fiona Scott Morton, and Glen Weyl contended that “the concentration of markets through large institutional investors is the major new antitrust challenge of our time.”  Those same authors took to the pages of the New York Times to argue that “[t]he great, but mostly unknown, antitrust story of our time is the astonishing rise of the institutional investor … and the challenge that it poses to market competition.”

Not surprisingly, these scholars have gone beyond just identifying a potential problem; they have also advocated policy solutions.  Elhauge has called for allowing government enforcers and private parties to use Section 7 of the Clayton Act, the provision primarily used to prevent anticompetitive mergers, to police institutional investors’ ownership of minority positions in competing firms.  Posner et al., concerned “that private litigation or unguided public litigation could cause problems because of the interactive nature of institutional holdings on competition,” have proposed that federal antitrust enforcers adopt an enforcement policy that would encourage institutional investors either to avoid common ownership of firms in concentrated industries or to limit their influence over such firms by refraining from voting their shares.

The position of these scholars is thus (1) that common ownership by institutional investors significantly diminishes competition in concentrated industries, and (2) that additional antitrust intervention—beyond generally applicable rules on, say, hub-and-spoke conspiracies and anticompetitive information exchanges—is appropriate to prevent competitive harm.

Mike Sykuta and I have recently posted a paper taking issue with this two-pronged view.  With respect to the first prong, we contend that there are serious problems with both the theory of competitive harm stemming from institutional investors’ common ownership and the empirical evidence that has been marshalled in support of that theory.  With respect to the second, we argue that even if competition were softened by institutional investors’ common ownership of small minority interests in competing firms, the unintended negative consequences of an antitrust fix would outweigh any benefits from such intervention.

Over the next few days, we plan to unpack some of the key arguments in our paper, The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms.  In the meantime, we encourage readers to download the paper and send us any comments.

The paper’s abstract is below the fold. Continue Reading…

I just posted a new ICLE white paper, co-authored with former ICLE Associate Director, Ben Sperry:

When Past Is Not Prologue: The Weakness of the Economic Evidence Against Health Insurance Mergers.

Yesterday the hearing in the DOJ’s challenge to stop the Aetna-Humana merger got underway, and last week phase 1 of the Cigna-Anthem merger trial came to a close.

The DOJ’s challenge in both cases is fundamentally rooted in a timeworn structural analysis: More consolidation in the market (where “the market” is a hotly-contested issue, of course) means less competition and higher premiums for consumers.

Following the traditional structural playbook, the DOJ argues that the Aetna-Humana merger (to pick one) would result in presumptively anticompetitive levels of concentration, and that neither new entry not divestiture would suffice to introduce sufficient competition. It does not (in its pretrial brief, at least) consider other market dynamics (including especially the complex and evolving regulatory environment) that would constrain the firm’s ability to charge supracompetitive prices.

Aetna & Humana, for their part, contend that things are a bit more complicated than the government suggests, that the government defines the relevant market incorrectly, and that

the evidence will show that there is no correlation between the number of [Medicare Advantage organizations] in a county (or their shares) and Medicare Advantage pricing—a fundamental fact that the Government’s theories of harm cannot overcome.

The trial will, of course, feature expert economic evidence from both sides. But until we see that evidence, or read the inevitable papers derived from it, we are stuck evaluating the basic outlines of the economic arguments based on the existing literature.

A host of antitrust commentators, politicians, and other interested parties have determined that the literature condemns the mergers, based largely on a small set of papers purporting to demonstrate that an increase of premiums, without corresponding benefit, inexorably follows health insurance “consolidation.” In fact, virtually all of these critics base their claims on a 2012 case study of a 1999 merger (between Aetna and Prudential) by economists Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan, Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry, as well as associated testimony by Prof. Dafny, along with a small number of other papers by her (and a couple others).

Our paper challenges these claims. As we summarize:

This white paper counsels extreme caution in the use of past statistical studies of the purported effects of health insurance company mergers to infer that today’s proposed mergers—between Aetna/Humana and Anthem/Cigna—will likely have similar effects. Focusing on one influential study—Paying a Premium on Your Premium…—as a jumping off point, we highlight some of the many reasons that past is not prologue.

In short: extrapolated, long-term, cumulative, average effects drawn from 17-year-old data may grab headlines, but they really don’t tell us much of anything about the likely effects of a particular merger today, or about the effects of increased concentration in any particular product or geographic market.

While our analysis doesn’t necessarily undermine the paper’s limited, historical conclusions, it does counsel extreme caution for inferring the study’s applicability to today’s proposed mergers.

By way of reference, Dafny, et al. found average premium price increases from the 1999 Aetna/Prudential merger of only 0.25 percent per year for two years following the merger in the geographic markets they studied. “Health Insurance Mergers May Lead to 0.25 Percent Price Increases!” isn’t quite as compelling a claim as what critics have been saying, but it’s arguably more accurate (and more relevant) than the 7 percent price increase purportedly based on the paper that merger critics like to throw around.

Moreover, different markets and a changed regulatory environment alone aren’t the only things suggesting that past is not prologue. When we delve into the paper more closely we find even more significant limitations on the paper’s support for the claims made in its name, and its relevance to the current proposed mergers.

The full paper is available here.

This week, the International Center for Law & Economics filed comments  on the proposed revision to the joint U.S. Federal Trade Commission (FTC) – U.S. Department of Justice (DOJ) Antitrust-IP Licensing Guidelines. Overall, the guidelines present a commendable framework for the IP-Antitrust intersection, in particular as they broadly recognize the value of IP and licensing in spurring both innovation and commercialization.

Although our assessment of the proposed guidelines is generally positive,  we do go on to offer some constructive criticism. In particular, we believe, first, that the proposed guidelines should more strongly recognize that a refusal to license does not deserve special scrutiny; and, second, that traditional antitrust analysis is largely inappropriate for the examination of innovation or R&D markets.

On refusals to license,

Many of the product innovation cases that have come before the courts rely upon what amounts to an implicit essential facilities argument. The theories that drive such cases, although not explicitly relying upon the essential facilities doctrine, encourage claims based on variants of arguments about interoperability and access to intellectual property (or products protected by intellectual property). But, the problem with such arguments is that they assume, incorrectly, that there is no opportunity for meaningful competition with a strong incumbent in the face of innovation, or that the absence of competitors in these markets indicates inefficiency … Thanks to the very elements of IP that help them to obtain market dominance, firms in New Economy technology markets are also vulnerable to smaller, more nimble new entrants that can quickly enter and supplant incumbents by leveraging their own technological innovation.

Further, since a right to exclude is a fundamental component of IP rights, a refusal to license IP should continue to be generally considered as outside the scope of antitrust inquiries.

And, with respect to conducting antitrust analysis of R&D or innovation “markets,” we note first that “it is the effects on consumer welfare against which antitrust analysis and remedies are measured” before going on to note that the nature of R&D makes it effects very difficult to measure on consumer welfare. Thus, we recommend that the the agencies continue to focus on actual goods and services markets:

[C]ompetition among research and development departments is not necessarily a reliable driver of innovation … R&D “markets” are inevitably driven by a desire to innovate with no way of knowing exactly what form or route such an effort will take. R&D is an inherently speculative endeavor, and standard antitrust analysis applied to R&D will be inherently flawed because “[a] challenge for any standard applied to innovation is that antitrust analysis is likely to occur after the innovation, but ex post outcomes reveal little about whether the innovation was a good decision ex ante, when the decision was made.”

As regulatory review of the merger between Aetna and Humana hits the homestretch, merger critics have become increasingly vocal in their opposition to the deal. This is particularly true of a subset of healthcare providers concerned about losing bargaining power over insurers.

Fortunately for consumers, the merger appears to be well on its way to approval. California recently became the 16th of 20 state insurance commissions that will eventually review the merger to approve it. The U.S. Department of Justice is currently reviewing the merger and may issue its determination as early as July.

Only Missouri has issued a preliminary opinion that the merger might lead to competitive harm. But Missouri is almost certain to remain an outlier, and its analysis simply doesn’t hold up to scrutiny.

The Missouri opinion echoed the Missouri Hospital Association’s (MHA) concerns about the effect of the merger on Medicare Advantage (MA) plans. It’s important to remember, however, that hospital associations like the MHA are not consumer advocacy groups. They are trade organizations whose primary function is to protect the interests of their member hospitals.

In fact, the American Hospital Association (AHA) has mounted continuous opposition to the deal. This is itself a good indication that the merger will benefit consumers, in part by reducing hospital reimbursement costs under MA plans.

More generally, critics have argued that history proves that health insurance mergers lead to higher premiums, without any countervailing benefits. Merger opponents place great stock in a study by economist Leemore Dafny and co-authors that purports to show that insurance mergers have historically led to seven percent higher premiums.

But that study, which looked at a pre-Affordable Care Act (ACA) deal and assessed its effects only on premiums for traditional employer-provided plans, has little relevance today.

The Dafny study first performed a straightforward statistical analysis of overall changes in concentration (that is, the number of insurers in a given market) and price, and concluded that “there is no significant association between concentration levels and premium growth.” Critics never mention this finding.

The study’s secondary, more speculative, analysis took the observed effects of a single merger — the 1999 merger between Prudential and Aetna — and extrapolated for all changes in concentration (i.e., the number of insurers in a given market) and price over an eight-year period. It concluded that, on average, seven percent of the cumulative increase in premium prices between 1998 and 2006 was the result of a reduction in the number of insurers.

But what critics fail to mention is that when the authors looked at the actual consequences of the 1999 Prudential/Aetna merger, they found effects lasting only two years — and an average price increase of only one half of one percent. And these negligible effects were restricted to premiums paid under plans purchased by large employers, a critical limitation of the studies’ relevance to today’s proposed mergers.

Moreover, as the study notes in passing, over the same eight-year period, average premium prices increased in total by 54 percent. Yet the study offers no insights into what was driving the vast bulk of premium price increases — or whether those factors are still present today.  

Few sectors of the economy have changed more radically in the past few decades than healthcare has. While extrapolated effects drawn from 17-year-old data may grab headlines, they really don’t tell us much of anything about the likely effects of a particular merger today.

Indeed, the ACA and current trends in healthcare policy have dramatically altered the way health insurance markets work. Among other things, the advent of new technologies and the move to “value-based” care are redefining the relationship between insurers and healthcare providers. Nowhere is this more evident than in the Medicare and Medicare Advantage market at the heart of the Aetna/Humana merger.

In an effort to stop the merger on antitrust grounds, critics claim that Medicare and MA are distinct products, in distinct markets. But it is simply incorrect to claim that Medicare Advantage and traditional Medicare aren’t “genuine alternatives.”

In fact, as the Office of Insurance Regulation in Florida — a bellwether state for healthcare policy — concluded in approving the merger: “Medicare Advantage, the private market product, competes directly with Traditional Medicare.”

Consumers who search for plans at Medicare.gov are presented with a direct comparison between traditional Medicare and available MA plans. And the evidence suggests that they regularly switch between the two. Today, almost a third of eligible Medicare recipients choose MA plans, and the majority of current MA enrollees switched to MA from traditional Medicare.

True, Medicare and MA plans are not identical. But for antitrust purposes, substitutes need not be perfect to exert pricing discipline on each other. Take HMOs and PPOs, for example. No one disputes that they are substitutes, and that prices for one constrain prices for the other. But as anyone who has considered switching between an HMO and a PPO knows, price is not the only variable that influences consumers’ decisions.

The same is true for MA and traditional Medicare. For many consumers, Medicare’s standard benefits, more-expensive supplemental benefits, plus a wider range of provider options present a viable alternative to MA’s lower-cost expanded benefits and narrower, managed provider network.

The move away from a traditional fee-for-service model changes how insurers do business. It requires larger investments in technology, better tracking of preventive care and health outcomes, and more-holistic supervision of patient care by insurers. Arguably, all of this may be accomplished most efficiently by larger insurers with more resources and a greater ability to work with larger, more integrated providers.

This is exactly why many hospitals, which continue to profit from traditional, fee-for-service systems, are opposed to a merger that promises to expand these value-based plans. Significantly, healthcare providers like Encompass Medical Group, which have done the most to transition their services to the value-based care model, have offered letters of support for the merger.

Regardless of their rhetoric — whether about market definition or historic precedent — the most vocal merger critics are opposed to the deal for a very simple reason: They stand to lose money if the merger is approved. That may be a good reason for some hospitals to wish the merger would go away, but it is a terrible reason to actually stop it.

[This post was first published on June 27, 2016 in The Hill as “Don’t believe the critics, Aetna-Humana merger a good deal for consumers“]

For several decades, U.S. federal antitrust enforcers, on a bipartisan basis, have publicly supported the proposition that antitrust law seeks to advance consumer welfare by promoting economic efficiency and vigorous competition on the merits.  This reflects an economic interpretation of the antitrust laws adopted by the Supreme Court beginning in the late 1970s, inspired by the scholarship of Robert Bork and other law and economics experts.  As leading antitrust scholars Judge (and Professor) Douglas Ginsburg and Professor Joshua Wright have explained (footnotes omitted), the “economic approach” to antitrust has benefited the American economy and consumers:

The promotion of economic welfare as the lodestar of antitrust laws—to the exclusion of social, political, and protectionist goals—transformed the state of the law and restored intellectual coherence to a body of law Robert Bork had famously described as paradoxical. Indeed, there is now widespread agreement that this evolution toward welfare and away from noneconomic considerations has benefitted consumers and the economy more broadly. Welfare-based standards have led to greater predictability in judicial and agency decision making. They also rule out theories of liability (e.g., a transaction will tend to reduce the number of small businesses in a market) and defenses (e.g., the restraint upon trade is necessary to save consumers from the consequences of competition) that would significantly harm consumers.

It is therefore most regrettable that the Attorney General of the United States, who oversees U.S. Executive Branch antitrust enforcement (which is carried out by the U.S. Justice Department’s Antitrust Division), recently delivered a speech on federal antitrust enforcement that is, at the very least, in severe tension with the (up to now) bipartisan federal antitrust enforcement consensus regarding the efficiency-centered goal of antitrust.  In an April 6 keynote luncheon address to the Spring Meeting of the American Bar Association’s (ABA) Antitrust Section, Attorney General Loretta E. Lynch focused instead on the themes of “fairness” and “economic justice” in discussing American antitrust enforcement:

[The ABA Antitrust Section] ha[s] always stood at the forefront of the Bar’s [laudable] efforts to guarantee fair competition; to encourage transparent business practices; and, above all, to secure economic justice. . . .  [O]ur choices have always been steeped in fundamental fairness.  The Sherman [Antitrust] Act was also a landmark in the history of the Department of Justice, adding the maintenance of a level economic playing field to our fundamental mission of upholding the law and seeking justice.  And the principle that it embodied – that the people of this country deserve the freedom to navigate their own path and chart their own future – still stands at the core of our work.  Today, the Department of Justice is as committed to fair, open and competitive markets as it has ever been. . . .  All of us in this room have a responsibility to stand up for people where they cannot stand up for themselves.  We have a duty to defend the institutions that make this country strong . . . [including] markets that allow for competition that is fair, . . . [and] a nation where every person has a meaningful chance to succeed and to thrive. . . .  [A]ll of you are making a significant and lasting contribution to a stronger and more just society. 

“Fairness” and “economic justice” may be laudable (albeit ill-defined) social goals in the abstract, but antitrust is ill-suited to advance them.  Indeed, history demonstrates that invocation of those goals was associated with welfare-inimical American antitrust enforcement policies that ill-served the American public.  Prior to the 1970s, “fairness,” “justice,” and related concepts (such as “a level playing field”) were often cited by the courts and public enforcers to justify antitrust interventions aimed at protecting entrenched small businesses from more efficient competitors, and at precluding the aggressive exploitation of efficiencies by large innovative companies.  This often resulted in higher prices to consumers, sluggish economic productivity, and slower innovation and economic growth, to the detriment of the overall American economy.

Admittedly, modern U.S. federal antitrust case law holdings and enforcement tools emphasize economic efficiency, rather than “fairness” and “justice,” so one might be tempted to dismiss the Attorney General’s remarks as unfortunate but of no real consequence.  (In fairness, the Attorney General did pay lip service to the importance of competition and to recent enforcement victories by the Antitrust Division, although inexplicably she had nothing to say about cartel prosecutions – the one area of antitrust that is most clearly welfare-enhancing.)  Unfortunately, however, many foreign antitrust enforcement officials and practitioners attended her speech, which by now has been disseminated throughout the global antitrust enforcement community.  Significantly, a number of major foreign jurisdictions have recently employed antitrust concepts of “unfair competition” and “superior bargaining position” to attack efficient, economic welfare-enhancing business arrangements, such as patent licensing restrictions, by major companies (including U.S. multinationals).  When American competition experts urge foreign antitrust officials to eschew such tactics in favor of efficiency-based antitrust rules, it would not be surprising to see those officials invoke Attorney General Lynch’s unfortunate paean to “fairness” in defense of their approach.  (For this reason, U.S. Federal Trade Commissioner Maureen Ohlhausen has stressed that American officials should be careful in their public antitrust pronouncements, a warning that obviously went unheeded by the Attorney General’s April 6 speechwriter.)

One may only hope that going forward, Attorney General Lynch, and the U.S. antitrust enforcers who report to her, will keep these concerns in mind and publicly reaffirm their dedication to the accepted mainstream consensus view that American antitrust policy is based on efficiency and consumer welfare considerations, not on bygone populist nostrums of “fairness.”  In so doing, U.S. officials should emphasize that efficiency-based antitrust strengthens innovation, advances consumer welfare, and fosters strong economies, considerations that ideally should prove attractive to public officials from all jurisdictions.

Today the International Center for Law & Economics (ICLE) submitted an amicus brief to the Supreme Court of the United States supporting Apple’s petition for certiorari in its e-books antitrust case. ICLE’s brief was signed by sixteen distinguished scholars of law, economics and public policy, including an Economics Nobel Laureate, a former FTC Commissioner, ten PhD economists and ten professors of law (see the complete list, below).

Background

Earlier this year a divided panel of the Second Circuit ruled that Apple “orchestrated a conspiracy among [five major book] publishers to raise ebook prices… in violation of § 1 of the Sherman Act.” Significantly, the court ruled that Apple’s conduct constituted a per se unlawful horizontal price-fixing conspiracy, meaning that the procompetitive benefits of Apple’s entry into the e-books market was irrelevant to the liability determination.

Apple filed a petition for certiorari with the Supreme Court seeking review of the ruling on the question of

Whether vertical conduct by a disruptive market entrant, aimed at securing suppliers for a new retail platform, should be condemned as per se illegal under Section 1 of the Sherman Act, rather than analyzed under the rule of reason, because such vertical activity also had the alleged effect of facilitating horizontal collusion among the suppliers.

Summary of Amicus Brief

The Second Circuit’s ruling is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. ICLE’s brief urges the Court to review the case in order to resolve the significant uncertainty created by the Second Circuit’s ruling, particularly for the multi-sided platform companies that epitomize the “New Economy.”

As ICLE’s brief discusses, the Second Circuit committed several important errors in its ruling:

First, As the Supreme Court held in Leegin, condemnation under the per se rule is appropriate “only for conduct that would always or almost always tend to restrict competition” and “only after courts have had considerable experience with the type of restraint at issue.” Neither is true in this case. Businesses often employ one or more forms of vertical restraints to make entry viable, and the Court has blessed such conduct, categorically holding in Leegin that “[v]ertical price restraints are to be judged according to the rule of reason.”

Furthermore, the conduct at issue in this case — the use of “Most-Favored Nation Clauses” in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing — have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.

Second, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko: “Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare.

This case involves vertical conduct essentially indistinguishable from conduct that the Supreme Court has held to be subject to the rule of reason. But under the Second Circuit’s approach, the adoption of these sorts of efficient vertical restraints could be challenged as a per se unlawful effort to “facilitate” horizontal price fixing, significantly deterring their use. The lower court thus ignored the Supreme Court’s admonishment not to apply the antitrust laws in a way that makes the use of a particular business model “more attractive based on the per se rule” rather than on “real market conditions.”

Third, the court based its decision that per se review was appropriate largely on the fact that e-book prices increased following Apple’s entry into the market. But, contrary to the court’s suggestion, it has long been settled that such price increases do not make conduct per se unlawful. In fact, the Supreme Court has held that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”  

Competition occurs on many dimensions other than just price; higher prices alone don’t necessarily suggest decreased competition or anticompetitive effects. Instead, higher prices may accompany welfare-enhancing competition on the merits, resulting in greater investment in product quality, reputation, innovation or distribution mechanisms.

The Second Circuit presumed that Amazon’s e-book prices before Apple’s entry were competitive, and thus that the price increases were anticompetitive. But there is no support in the record for that presumption, and it is not compelled by economic reasoning. In fact, it is at least as likely that the change in Amazon’s prices reflected the fact that Amazon’s business model pre-entry resulted in artificially low prices, and that the price increases following Apple’s entry were the product of a more competitive market.

Previous commentary on the case

For my previous writing and commentary on the the case, see:

  • “The Second Circuit’s Apple e-books decision: Debating the merits and the meaning,” American Bar Association debate with Fiona Scott-Morton, DOJ Chief Economist during the Apple trial, and Mark Ryan, the DOJ’s lead litigator in the case, recording here
  • Why I think the Apple e-books antitrust decision will (or at least should) be overturned, Truth on the Market, here
  • Why I think the government will have a tough time winning the Apple e-books antitrust case, Truth on the Market, here
  • The procompetitive story that could undermine the DOJ’s e-books antitrust case against Apple, Truth on the Market, here
  • How Apple can defeat the DOJ’s e-book antitrust suit, Forbes, here
  • The US e-books case against Apple: The procompetitive story, special issue of Concurrences on “E-books and the Boundaries of Antitrust,” here
  • Amazon vs. Macmillan: It’s all about control, Truth on the Market, here

Other TOTM authors have also weighed in. See, e.g.:

  • The Second Circuit Misapplies the Per Se Rule in U.S. v. Apple, Alden Abbott, here
  • The Apple E-Book Kerfuffle Meets Alfred Marshall’s Principles of Economics, Josh Wright, here
  • Apple and Amazon E-Book Most Favored Nation Clauses, Josh Wright, here

Amicus Signatories

  • Babette E. Boliek, Associate Professor of Law, Pepperdine University School of Law
  • Henry N. Butler, Dean and Professor of Law, George Mason University School of Law
  • Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
  • Stan Liebowitz, Ashbel Smith Professor of Economics, School of Management, University of Texas-Dallas
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Scott E. Masten, Professor of Business Economics & Public Policy, Stephen M. Ross School of Business, The University of Michigan
  • Alan J. Meese, Ball Professor of Law, William & Mary Law School
  • Thomas D. Morgan, Professor Emeritus, George Washington University Law School
  • David S. Olson, Associate Professor of Law, Boston College Law School
  • Joanna Shepherd, Professor of Law, Emory University School of Law
  • Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics,  The George L. Argyros School of Business and Economics and Professor of Economics and Law, Dale E. Fowler School of Law, Chapman University
  • Michael E. Sykuta, Associate Professor, Division of Applied Social Sciences, University of Missouri-Columbia
  • Alex Tabarrok, Bartley J. Madden Chair in Economics at the Mercatus Center and Professor of Economics, George Mason University
  • David J. Teece, Thomas W. Tusher Professor in Global Business and Director, Center for Global Strategy and Governance, Haas School of Business, University of California Berkeley
  • Alexander Volokh, Associate Professor of Law, Emory University School of Law
  • Joshua D. Wright, Professor of Law, George Mason University School of Law