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E-MailYaron Nili is Assistant Professor of Law at the University of Wisconsin-Madison Law School. This post is based on his recent paper, forthcoming in the Northwestern University Law Review.
Common ownership has garnered significant attention in both antitrust and corporate governance discourse. Scholars have long been concerned that monopolies, cartels, and other forms of coordination can harm consumers. In recent years, prominent scholars have also raised concerns regarding companies’ incentives to compete where major institutional shareholders hold large equity positions in all competitors.
Yet, as the common ownership debate endures, another channel that may enable companies to coordinate, and has similar antitrust and governance concerns has received little attention. My paper, Horizontal Directors, spotlights the surprising prevalence of directors who serve on the boards of multiple companies within the same industry and who may also facilitate coordination that may lead to anticompetitive behavior. Against this empirical backdrop, the paper explores the benefits horizontal directors provide to companies and investors, as well as the antitrust and governance concerns that they may pose, and puts forward several policy recommendation to regulators and investors. Below I summarize some of the key findings:
Horizontal directorships are extremely prevalent
Empirically, the paper collects and analyze comprehensive data on all directors in the S&P 1500 companies between 2010 and 2016, exploring important questions regarding the prevalence, industry concentration and the individual attributes of horizontal directors. The data reveals that horizontal directors are exceedingly prevalent across public boards and that the number and percentage of horizontal directors steadily increased during the sample period. At the same time, corporate disclosure of directors’ concurrent horizontal positions remains sparse, which may have prevented shareholders and regulators from realizing the prevalence of horizontal directorships.
For example, in 2016, there were 2,180 directors (49% of all directors serving on more than one board) who served on the boards of at least two companies within the same industry. Even when using the narrower four-digit SIC codes, the number of horizontal directors was significant. Indeed, 499 directors (11.3% of the directors serving on more than one board) served on at least two companies’ boards within the same four-digit SIC code in 2016. The results remain similar when using NAICS codes: 369 directors (8.4% of the directors serving on more than one board) served on at least two companies’ boards within a single NAICS code. Moreover, the percentage of companies having at least one horizontal director is also significant. In 2016, 81.1% of companies had at least one industry horizontal director on their board, and 26.8% of the companies had at least one director who served on boards of two or more companies within their same SIC code.
Horizontal directors and competition
This large presence of horizontal directors amongst public corporations is particularly striking in light of current antitrust laws. Section 8 of the Clayton Act prohibits horizontal directorships in competing corporations, in order to prevent the shared director from purposefully or inadvertently facilitating anticompetitive behaviors between the firms. Yet, despite this prohibition, a significant number of directors serve on boards in the same industry, even narrowly defined. While industry measures, even narrow as the NACIS and SIC classifications, are only a crude proxy for the potential of two companies to compete, it is nevertheless more likely that two companies operating in the same space could indeed be considered competitors.
Section 8 lacks a bright line rule understanding of the “competitors” prerequisite, and the enforcement of Section 8 involves discretion, negotiations and amicability, as well as lack of publicity. These factors have left gaping gray zones, allowing horizontal directors to become the rule rather than the exception. And while service on the boards of two competitors may be concerning in and of itself, there is reason to become even more concerned. The increased prevalence of horizontal directors comes against a backdrop of increasing concentration of the U.S. markets, with more than 75% of U.S. industries experienced a rise in concentration levels in recent years. As industries become more concentrated, the anticompetitive concerns of collusion and price fixing intensify, thereby escalating the potential impact of horizontal directors.
Horizontal directors and corporate governance
In many ways, horizontal directors epitomize the push and pull of the U.S. corporate governance system. Directors are supposed to provide investors and companies numerous functions: they monitor management, provide expertise and networking, and make the corporation’s most important decisions. Yet, companies often lean on outsiders to serve as directors, and allow (and even encourage) their service on other boards for the benefits it may entail. Indeed, many directors, when given the opportunity, elect to serve on more than one board. Yet, service on other boards often also entails costs. Shining a light on horizontal directors enriches the current discourse regarding director busyness and the benefits and costs it entails. The horizontal feature of directorships adds a new layer of complexity to the way that director busyness can affect the companies that directors serve. Horizontal directors may provide much needed industry specific expertise and networking, but may also increase the concerns of systemic governance risk, or compromise director independence, board composition, and pay practices.
Importantly, horizontal directors stand at the intersection of antitrust law and corporate governance. Antitrust laws are intended to prevent competitors from colluding at the expense of consumers, while corporate governance focuses on increasing shareholder welfare. Since shareholders and consumers are often at odds, horizontal directors strain this subtle distinction to its fullest. On the one hand, horizontal directors may enable companies to coordinate or collude at the expense of consumers, and in fact, they could provide a much simpler route for collusion or unlawful coordination than currently suggested by common ownership scholars. Yet, the same coordination may actually prove beneficial to shareholders of these companies, allowing them to increase profits by requiring consumers to pay more. This ultimately would improve company performance and shareholder value.
Next steps
In light of the empirical findings, and the inherent tension that horizontal directors embed, regulators and legislators should reevaluate the current regulatory framework governing horizontal directors. If horizontal directorship contributes to anti-competitiveness, focusing the regulatory prohibition on concentrated industries might strike a desired balance—allowing companies to enjoy the benefits these directors provide while prohibiting their presence in cases where the costs to competition likely outweigh these benefits. Additionally, regulators could consider allowing directors to apply for a waiver prior to accepting a horizontal directorship. This would allow companies to have certainty that their existing directors are not violating Section 8. It would also give companies the ability to have the FTC grant a veto right ex-ante to justify a director nomination that otherwise could violate Section 8. This would ultimately reduce the need for costly ex-post enforcement. Revising the restrictions on horizontal directorship would also require a more predictable, public, and effective enforcement mechanism.
Investors, too, should direct their attention to the issue of horizontal directorship. Understanding that not all companies are created equal, investors may be better situated than regulators to account for the rise in horizontal directorships and to offer market based solutions to the inherent tension that these directors present. Whether viewing horizontal directors as a corporate governance liability or as a potential benefit, a strong case for improved disclosure exists. Companies are not currently required to provide detailed information regarding the other companies on which a director serves and are only required to provide data for the past five years. This lack of sufficiently detailed disclosure regarding a director’s other board positions may camouflage the presence of horizontal directorships and prevent shareholders from easily identifying directors that are horizontal and the corresponding benefits and costs they may present. Importantly, even if shareholders believe that horizontal directors are a net benefit, they may still want companies to properly disclose this information. Enhanced disclosure would allow investors to not only to affirm the judgment of the board as to each director, but also to possess a better understanding of whether, as a whole, the presence of each horizontal director is beneficial to the company.
This paper builds on some of my previous work about boards here, here, here and here.
The complete paper is available for download here.
