Common ownership scare shows flaws in economic research

In December, the Federal Trade Commission (FTC) held a hearing in New York on “common ownership.” This bland phrase disguises a topic of vindaloo hotness: Are index funds really cartels? Should they be regulated out of existence?

Last year, the FTC stirred this pot repeatedly. In June, at the Global Antitrust Economics Conference, in his first public remarks FTC Commissioner Noah Joshua Phillips aired the theory that it is harmful for “diversified institutional investors to hold partial interests in competing corporations.”

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Phillips was skeptical but saw a need to give the idea a respectful hearing. The claim that index funds somehow benefit fund managers and investors at the expense of consumers has been rattling around since 2015 — rattling like a chain without an anchor.

The problem for the anti-indexers is that they have no real evidence. The chain of inference was first hauled out when a paper by Professors José Azar, Martin Schmalz and Isabel Tecu started circulating in unpublished form in 2015 and eventually published form in 2018 in the Journal of Finance.  

Azar, Schmalz and Tecu conjured the specter that “common ownership” dampens competition among companies and thus raises prices to consumers. Their evidence? They have none. What they have is a model.

Their statistical analysis conjures a ghostly clue that when the asset management firm BlackRock invested in airline companies, airline ticket prices went up.

The normal fluctuation of prices in the volatile airline industry could be correlated just as easily with rebound averages in the NBA. Never mind that. Suddenly someone had a theory that the evil asset management firms had a magic trick to manipulate markets. The sweet scent of government regulation was wafted toward would-be regulators.

To its credit, the FTC has not taken the bait. Commissioner Phillips intoned, “The large institutional investors do not appear to be at the apex of a massive antitrust conspiracy.” 

But conspiracies, as we all know, die hard. The FTC has continued to indulge the conspiracy theorists, most recently by giving them a stage at the eighth FTC hearing on "Competition and Consumer Protection in the 21st Century."

We don’t claim expertise in this area. One of us is an anthropologist, and the other is a historian. We come to the topic of “common ownership” because we are examining misuses of scientific authority, and when irreproducible science is summoned to support irresponsible regulation, our alarms go off. “Common ownership” is a klaxon horn.

The article by Azar et al. prompted law professor Eric Posner and several colleagues to draft “A Proposal to Limit the Anti-Competitive Power of Institutional Investors,” which would tightly regulate the way institutional investors could invest in rival firms.

The FTC didn’t endorse Posner’s argument, but it left the door open for the FTC and the Securities and Exchange Commission to investigate asset management firms. That action has already diverted those firms from their proper work in order to fight off a regulatory assault.

The hubbub is based on mere vapor. Azar and his colleagues said they found a significant effect, but other scholars haven’t been able to find it in the data. Some criticize the trio for looking for a statistical test to support a predetermined conclusion.

Others criticize their handling of the data. So we have arrived at a point where an elusive statistical error could move the FTC to regulate an industry that’s done nothing wrong.

Economics is one of many disciplines afflicted with a surfeit of irreproducible research. Investigators in 2015 were unable to substantiate more than half of a sample of 67 peer-reviewed economics articles. A 2016 study found widespread exaggeration in the size of claimed effects.

For good reason, the FTC requires its rules to be based on reproducible findings, but the “common ownership” scare shows the need for tighter standards. We need transparency with data and methods and actual reproducibility. 

We live in an age of statistical rascality, especially among those who are on the prowl to advance the cause of regulation. Our watchdogs need to be more wary and not go barking simply because someone else is.

Index funds have been a boon to investors with no discernible harm to marketplace competition. A greater danger is inviting unproven conspiracy theories conjured out of statistical thin air to take a seat at the regulatory table.

Peter Wood is the director of the National Association of Scholars (NAS). David Randall is the director of research at NAS.