“The practice of interlocking directorates is the root of many evils. It offends laws human and divine.”
— Justice Louis Brandeis.
Introduction
Antitrust law prohibits competing corporations from sharing board members (so-called “interlocking directorates”) and has for more than a century.
The main idea is that if the same person serves on the boards of two competing companies, they may discourage one of their companies from competing vigorously against the other, and the information and connections they have make it easier for those companies to collude.
So we prohibit people from serving on the boards of companies that compete even in part.
It’s a simple rule—one that is easy to observe—and violating it is one of the few things antitrust declares illegal per se, with no opportunity to explain or justify the interlock.
We show that large numbers of companies are directly violating that law and that the problem goes well beyond simply breaking the law. Using a dataset that enables us to provide the first analysis of board members on both public and private companies—rather than just public companies
—we find 2,309 instances of individuals sitting on the boards of two companies that are direct competitors. The extent of interlocks is so great that for those companies for which we have data on at least five board members, 8.1% had an individual interlock.
Showing that director interlocks occur in private and smaller companies is important because private companies account for 99% of all businesses
and 87% of all businesses earning more than $100 million annually.
Our broad view of the economy reveals that overlapping directorates are particularly common in the innovation-rich information technology (IT) and life sciences industries.
In pharmaceutical and biotech companies, for instance, among those for which we have the best board data, 18.2% have at least one board director who also sits on the board of another firm that is identified as a direct competitor.
Among IT software companies, 10.5% had an interlocking board member.
This view of private companies underscores the high stakes of interlocking boards for innovation and the economy.
Besides showing that board interlocks are more widespread than public-company data would indicate, we contribute new evidence indicating several reasons why the problem of interlocking boards is more concerning than previously realized. First, we provide the first data about who these directors are in their day jobs outside of their occasional board meetings. About 65% of the individual interlocking directors we identified are leaders of private equity, venture capital, and other investment funds that invest in the very companies on whose boards these directors sit. Companies in anticompetitive industries earn greater profits and thus provide greater returns for investors. Partners of investment firms receive a share of investment profits.
Consequently, many interlocking board members are controlled by investors with strong financial incentives to promote anticompetitive conduct in the industry, so the directors have strong personal financial incentives to promote anticompetitive conduct. We are thus the first to show that many individual interlocking directors form part of an investment-industrial complex that did not exist when lawmakers made such interlocks illegal and that provides additional incentives for anticompetitive conduct.
Second, one of the great challenges in antitrust law is defining the market in a way that shows two firms are competitors rather than merely participating in the same industry.
Although prior studies of interlocking boards in public companies have begun to construct more careful classification systems for markets, they all rely on proxies for competition.
Our data, by contrast, relies on classifications used by investment funds themselves to identify competitors.
Thus, by providing a view of market definitions as industry itself defines competition, our Article adds weight to the conclusion that interlocking directors are indeed sitting on the boards of competitors.
Finally, the problem of interlocking boards extends well beyond individual directors serving on competitors’ boards. We show that the practice of investors having two or more employees serving on competitors’ boards is widespread throughout the economy.
This practice is even more common than individual interlocks, reaching 2,927 different companies and 9.9% of the companies with at least five board members in our dataset.
Again, most of these board members are senior-level employees sharing in the investor’s profits, who therefore have the opportunity and motivation to collude.
Once combined, individual and investor-level interlocks reach 13.4% of all companies—including 30.1% of pharmaceuticals and biotechnology companies and 16.9% of all IT and software companies.
Beyond these direct empirical contributions, we also bring into the legal literature a synthesis of important, recent research from other fields. The totality of our data and that other research suggests that interlocks raise significant anticompetitive concerns. Common directors offer boards expertise and other value that must be considered in determining the net impact of interlocking boards on society.
But there is evidence that interlocking boards lead to higher prices, fewer new product offerings, and—in the case of investor-level interlocks, at least—companies staying away from competitors’ markets.
It is illegal under antitrust law to collude on prices or divide the economy into territories to avoid competition.
Yet interlocks may provide a widespread mechanism to push their firms away from pursuing competing research agendas or to coordinate the raising of higher prices. Even if there is no collusion, the overlap between board members may dampen incentives to compete vigorously.
Given these stakes, it is remarkable that the rule against interlocking directorates has received little attention from antitrust scholars or (until very recently, and only mildly) from antitrust enforcers. Most cases brought against interlocking directorates are decades old,
though there has been a resurgence
in the wake of a smaller empirical study one of us coauthored showing the extent of the problem.
We were unable to find a single major law review article written in recent years focusing on the antitrust implications of interlocking directors.
That inattention is particularly noteworthy because antitrust scholars have in recent years devoted volumes to a different corporate governance issue: common ownership.
Common ownership refers to the same institutions, such as BlackRock and Vanguard, owning shares in competitors. A vibrant body of antitrust scholarship has debated whether antitrust should respond to the precipitous increase in partial common ownership in light of empirical evidence suggesting that such ownership is linked to reduced competition.
To be clear, we see the common ownership literature as valuable.
But overlapping share ownership is not itself illegal. Nor have scholars established a clear mechanism by which those common institutional owners harm competition.
After all, financial institutions like BlackRock and Vanguard do not actively manage the companies they own shares in.
Instead, they tend to passively hold shares of most publicly traded companies. So it is heavily contested whether and how broad-based ownership might be undermining competition.
In contrast, interlocking directors are more concretely problematic as a matter of influence and law. Unlike passive shareholders, the very purpose of board members is to actively participate in the governance of firms. Moreover, we show that these interlocking board members are often employed by an investor that does not simply passively hold shares but is instead a private equity or venture capital firm, groups known to aggressively intervene as investors. Most famously, private equity companies regularly take over and shut down or pare down companies.
And while evidence of anticompetitive harm would be needed to convict common owners for violating the law,
the mere existence of common directors at competing firms is already per se illegal, meaning no such evidence of harm is required.
And while investor-level board interlocks are of questionable legality,
they present similar mechanisms for collusion or other reductions in competition.
Thus, scholars have devoted volumes of research to a corporate governance practice whose mechanism for anticompetitive behavior and illegality are uncertain. But they have yet to turn their sustained attention to interlocking directors despite a tangible mechanism for anticompetitive behavior and an undisputed status of illegality. We seek to change that.
Our findings have important policy implications. One is obvious: Both companies and enforcers need to pay attention to and enforce the law. Now that the evidence exists to conclude that board interlocks may have significantly anticompetitive implications, there should be greater motivation to apply the law on the books. We show how authorities can do this under existing law even beyond the prohibition of individual interlocks. We argue that a case can be made for seeing “investor-level interlocks”—two or more of an investor’s employees sitting on competitors’ boards—as acting as agents under control of the investor. Thus, such arrangements are already arguably illegal under section 8 of the Clayton Act.
The problem with relying solely on section 8, for both individual and investor-level interlocks, is that it fails to eliminate incentives because the typical remedy is simply removing the board member—meaning that the companies earn the gains from any anticompetitive conduct until they are caught and forced to stop. Consequently, we propose that courts view both individual and investor-level interlocking board members as adding evidence of collusion when there are signs of anticompetitive outcomes. In such cases, two employees working for a profit-maximizing investor have the opportunity and motivation to collude. That legal shift would allow for large financial penalties and criminal sanctions, thus providing meaningful deterrence under existing law.
Structural reforms might further reduce illegal board conduct, whether accidental or purposeful. As one example, whenever firms above a certain value threshold merge, they must submit a report to the FTC for approval.
A similar reporting requirement might be appropriate whenever a sufficiently sizable company adds a director who is also on the board of another company in the same industry.
We also think the remarkable disconnect between what the law requires and what companies do raises the question of whether a universal ban on interlocks is appropriate. In areas in which there are simply too few real experts, such as some emerging industries, the benefits of board expertise for early-stage companies may outweigh the risks of anticompetitive influence. If that is true, it would have implications for antitrust law because it would suggest that in some contexts the per se rule against interlocking boards should be relaxed. What little scholarship there is focuses on the benefits and not the harms of interlocks, contributing to the notion that antitrust law is out of touch with modern corporate governance.
Our study should help shift the emphasis away from interlocking directors’ expertise to their influence and incentives. Previously, it would have been easier to portray these interlocking board members as simply high-in-demand, valuable board members whose very busyness simply happens to inadvertently create many innocent interlocks.
By providing insights into who these directors are and the broader investment infrastructure in which they sit, we show that such a generally optimistic view of interlocking directors is unwarranted. Antitrust law has not necessarily grown out of step with corporate governance. Corporate governance and the modern era of investment funding have combined to provide new ways of doing what the Clayton Act long ago sought to prohibit.
Indeed, there may be reason to expand the reach of the ban on interlocking directorates. First, many companies engage in conduct that is not currently a violation of the rule against interlocking directorates but that seems to have similar economic effects. The rule against interlocking directorates applies only to companies that are current competitors that draw revenue from the same market.
In the biotech industry, the process of regulatory approval takes years, and companies plan business strategies not only with respect to current competitors but vis-à-vis companies they can see have filed for approval of a new drug, even if the release of that drug is years away.
Common directors can influence business strategy in a way that restricts future competition, something a law written long before the FDA was created does not address.
We may want to expand the prohibition of interlocking directors to encompass pre-revenue companies with a realistic possibility of future competition, and there is a plausible argument that the statute was intended to encompass potential competitors.
Second, although we think that investor-level and not just personal interlocks should be seen as violations of the Clayton Act under existing law,
if they are not currently illegal, there may be reason to expand the prohibition against interlocking directorates. The laws prohibiting interlocks were written at a time when private equity and venture capital did not exist as we now know them, as incredible forces steering large portions of the economy.
But even if the same person doesn’t sit on the boards of competing companies, if partners of the same venture capital fund sit on competing boards, that raises similar concerns that animate the law against interlocking directorates.
Third, boards of directors have broadly failed to extend membership to women and minorities.
Multiple boards hiring the same people can exacerbate that problem. Thus, perhaps stronger antitrust law in this area would encourage not only innovation but also board diversity.
Finally, the surprising prevalence of common directors at both the individual and investor levels may help explain some of the otherwise puzzling economic effects of common ownership. Our data provides a basis for active investment funds, rather than solely passive investors, contributing to anticompetitive effects of common ownership. Active investors are also owners, albeit a different class of owners than those that were the focus of the common ownership literature. Further research is needed at the intersection of investors and interlocks to better understand the relationship to common ownership.
At a minimum, the complex analysis of whether interlocking directors are economically beneficial should be more explicit and informed by the sea of emerging evidence that it is problematic. Either companies need to follow the law, or policymakers should change that law if it is out of step with good policy. It is time to reexamine whether boards of directors can better serve competition with a healthier balance between norms and laws.
In Part I, we explain the history and doctrine of the law against interlocking directorates and how it fell into disuse in the past several decades before a recent revival. Part II introduces our empirical evidence and shows that potentially illegal board interlocks are widespread. In Part III, we discuss the effects of those interlocks on competition. Part IV suggests potential changes to the law and ways to encourage better compliance with it.