Hirschman and concentration

Another week, another story about industry and ownership concentration. As we’ve noted previously, a mixture of industry concentration within sectors, and ownership concentration in relation to firms, has started to attract some attention. A recent piece in the Wall Street Journal looked at the former, whilst an FT article this week focused on the latter, in particular the growing power of passive managers. The obvious link between the two is… Albert Hirschman. One way that regulators and others seek to assess the level of market concentration is by working out the Herfindahl-Hirschman Index (HHI). Named after two economists, Hirschman and Orris Herfindahl, the HHI score for an industry is worked out by summing the squared market shares of each firm in a sector. So if four firms dominate, with a market share of 25% (or 25 points), the HHI is 25% / 2500 points. This might sound abstract, but it is a measure that policymakers use, and firms detest. For example, back in 2012 PwC devoted an entire paper looking at the HHI in its defence of the audit market. Nonetheless the HHI does still get used, and there is a consensus that, looking at measures like it, even in developed markets like the US industry concentration is on the rise. According to a 2015 paper (updated last year) ’Are U.S. Industries Becoming More Concentrated?’ over the last two decades, over 75% of U.S. industries have experienced an increase in concentration levels. It found that while firms in industries with the largest increases in product market concentration have enjoyed higher profit margins and more profitable M&A deals, there was no evidence of a significant increase in operational efficiency. The authors concluded that this suggests that market power is becoming an important source of value. Meanwhile, on the ownership side of the fence, as we wrote last week, the ever increasing proportion of assets being managed passively means that concentration is occurring there to. Here again we might learn something from Hirschman. In Exit, Voice and Loyalty, probably the book for which he is most famous, Hirschman highlighted how differing constraints might change the suitability of different options. He wrote: ’[T]he actual level of voice feeds on an inelastic demand, or on the lack of an opportunity for exit. In this view, the role of voice would increase as the opportunities for exit decline, up to the point where, withexitwhollyunavailable, voicemustcarry the burden of alerting management to its failings.’ Well, if you’re passively tracking an index your options for exit are pretty much unavailable. This suggests that this should be the area where we see most shareholder engagement. Yet to date,
it doesn’t seem to have happened, whether that’s because – as a low-cost option – passive managers don’t want to expend too muchresource, conflicts of interest or a mixture of various factors. And is this really what we want to see – industries dominated by a handful of key firms accountable, at least notionally, to a handful of financial services giants? Far from democratising companies and capital, shareholder engagement and responsible investment could risk turning into an elite game played by highly-paid specialists on both sides. What would Hirschman have made of that?

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