Oct./Nov. 2002 - VOLUME 23 - NUMBER 10 & 11
T h e F u t u r e o f C o r p o r a t e R e f o r m
Consider the case of Clear Channel. The San Antonio-based firm controls 1,200 radio stations in the United States. Two years ago, it began buying up concert promotion firms. It now operates or exclusively books more than 100 concert venues across the United States, producing about 70 percent of live concerts in the country.
Clear Channel uses its radio stations to promote its concerts. Independent concert promoters allege the company refuses to permit its radio stations to promote independent shows, sometimes even failing to air paid advertisements for the concerts. Bands that appear on tours produced by rival concert promoters find that they may not get played on Clear Channel -- a devastating penalty to music groups dependent on radio play for exposure.
In August, a competing promoter, Nobody In Particular Presents (NIPP), filed suit against Clear Channel, alleging that the radio behemoth's leveraging of its market power in the concert promotion field violates antitrust rules.
The Clear Channel case indicates the potential harms of vertical integration and cross-industry ownership arrangements. When people think about antitrust, they usually have in mind horizontal concentration -- a single company's or handful of companies' share of a particular market. The story of how a single airline servicing a particular route can raise fares, or how food prices are higher where there are fewer supermarkets, is a familiar one.
Problems of vertical concentration (involving ownership of multiple elements of the supply and distribution chain for a particular product) are different. They typically involve companies leveraging their power in one market to exert influence over another -- as NIPP's suit alleges against Clear Channel -- or conflicts of interest in which a company acts improperly in one market to gain an advantage in another.
To the extent that this kind of leveraging of market power and influence poses problems, there are two possible responses. One is to examine potential problems on a case-by-case basis, with particular companies' actions reviewed against the backdrop of general antitrust principles. A second approach is to establish as a matter of law that certain kinds of cross-industry ownership, vertical integration or conglomeration are impermissible. This blanket approach reflects a decision that certain kinds of cross-ownership inherently pose too many risks, that policing individual cases is either not possible or too costly and difficult, that the benefits of cross-ownership are insufficient to offset the risks, and that clear rules should proscribe such ownership arrangements in all cases, before they occur.
In recent years, both of these approaches, especially the second, have fallen out of favor in the United States. It may be time to revitalize them.
Explaining Enron, et. al.
Take Arthur Andersen and the accounting industry. There is now broad agreement that the fuel for the accounting firms' failure to report on and call attention to their clients' improper accounting was a desire to serve as financial consultants to those same clients. The revenues from the steady auditing business paled compared to the earnings from providing consulting services; so the accountants put their seal of approval on cooked books to ingratiate themselves with clients and win or maintain consulting deals.
The Sarbanes-Oxley corporate accountability bill that passed Congress this past summer is designed to prevent such conflicts in the future. It restricts the non-audit services a public accounting firm may provide to clients that it audits.
The inflation of company stock values was assisted by the thunderous happy-talk from the Wall Street stock analysts. Those analysts were employed by firms that also provided investment banking services -- stock and bond underwriting, etc. -- for the very firms they were evaluating. While the Wall Street firms had insisted that "Chinese walls" divided their analysts from investment bankers, the extensive internal e-mails obtained by New York Attorney General Eliot Spitzer revealed a quite different story. In fact, the analysts were in many cases publicly touting stocks that they privately disparaged -- in large part, so their firms could obtain or maintain investment banking deals.
E-mails uncovered by Spitzer found one Merrill Lynch analyst calling the stock of Infospace, an Internet company, "a piece of junk," while Merrill Lynch gave Infospace -- a major investment banking client -- the firm's highest stock rating. Merrill Lynch analysts were calling stock for Lifeminders a "p.o.s.," -- Spitzer told a U.S. Senate committee, "Let me just say p.o.s. is a euphemism for an extremely poor investment" -- even as Merrill Lynch was recommending that the public buy the stock.
In an affidavit filed in connection with New York state's litigation against Merrill Lynch, Assistant Attorney General Eric Dinallo explained. "Research analysts knew that the investment banking business they generated or participated in would impact their compensation, and management encouraged them to produce investment banking business."
The methods of manipulation were shockingly crude. "Analysts curried favor with potential or actual investment banking clients by giving them special treatment," Dinallo stated. "At times, officers of clients or prospective clients were allowed to redraft their own coverage, write quotations in which the analysts would tout their companies, and indicate which rating would be acceptable to them."
There were no illusions inside Merrill Lynch about how the researchers shaped their analysis to satisfy clients and win investment banking business. A senior analyst at Merrill Lynch wrote in an e-mail, "the whole idea that we are independent of [the] banking [division] is a big lie." A senior manager wrote, "We are off base in how we rate stocks and how much we bend over backwards to accommodate banking."
Spitzer settled the Merrill Lynch case for a $100 million penalty and requirements that Merrill Lynch sever the link between compensation for analysts and investment banking, and that it create a new investment review committee responsible for approving all research recommendations.
While acknowledging the important job Spitzer did in bringing Wall Street wrongdoing to light, consumer advocates criticized the settlement for letting off Merrill on the cheap, and for failing to win meaningful structural reforms to split the investment banking and analyst functions at the firm.
In settlement talks to ongoing litigation, Spitzer also appears to have backed off from demands to force the Wall Street firms to divide their operations. At various times, the Wall Street firms have seemed willing to make such moves voluntarily; but more recently, they seem to believe they can wait out the public pressure. They are looking for a settlement with a less extreme divide between investment banking and research.
There is still a third element of conflicts of interest rising from combined functions in the recent financial scandals. Enron and other companies' elaborate financial shenanigans depended on their ability to borrow large sums of money from Citigroup and others. The borrowers recycled the money in various ways, but often failed to pay back the loans. Banks have a natural interest in having their loans repaid, so it is not immediately obvious why they would be willing to subsidize Enron and others with bad loans. The apparent answer is that banks sold the loans in exotic financial instruments to others, meaning they shed their financial self-interest in ensuring they made only good loans. Meanwhile, they allegedly used the loans to gain entr»e to perform extremely profitable investment banking services for the borrowers.
These financial conflicts of interest -- which directly contributed to the financial scandals that cost millions of investors billions of dollars -- are due entirely to companies' involvement in multiple financial service lines. Many of these conglomerations were barred just a few years ago. But federal regulatory authorities progressively loosened financial regulations in the 1990s, and then, in 1999, the Financial Services Modernization Act knocked down the legislative wall between banking and securities.
Taking Apart Telecom
One key rule involves the ban on cross-ownership between newspapers and television stations in the same local market. Even as competition between local newspapers has evaporated in all but a few U.S. cities; even as Gannett and other chains have bought up newspapers across the country; even as local television stations are owned by fewer and fewer corporations; there remains a bar on common ownership of newspapers and television networks. The FCC is seeking to repeal this cross-ownership restriction.
The FCC's argument is that newspapers and television basically do the same thing -- provide information -- so there is no more reason to fear cross-ownership than there is ownership by one entity of two local TV stations (permissible under FCC rules since 1999). Moreover, argues the FCC, the Internet is evolving as an information source to compete with TV and newspapers.
Public interest advocates are staunchly opposed to the FCC's proposal. "If local television broadcasters were allowed to merge with local newspapers, combining the two most important means by which consumers obtain news and information," argue the Consumer Federation of America, Consumers Union, the Media Access Project and other public interest groups in a filing with the FCC, "the combined owner's editorial bias and economic incentives to under-serve the needs of minorities will skew public discourse and thereby harm our nation's democracy."
While not romanticizing news coverage in newspapers, the consumer groups argue that newspapers do a better job of reporting, and offer unique services in the area of local news. "If the combination of newspaper and broadcast properties in a community leads newspapers to reduce their in-depth, investigative reporting in order to serve the more homogenized, superficial, mass-market advertiser-driven needs of broadcast television," the groups contend, "then Justice Brandeis' fear that we [will] become a society of couch potatoes, Žan inert people,' will be realized, undermining Ža fundamental principle of American government.'"
Moreover, the two media compete with one another, offering distinct perspectives on the news and especially local news. If permitted to merge -- even as concentration in each industry is on the rise -- homogenization and depoliticization will be the rule. The surge in radio consolidation -- driven above all by Clear Channel -- illustrates how "local content can be homogenized off the air," the groups argue.
There are other hot-button cross-industry issues in play in media market regulation, especially the nexus between content and conduit in the cable television/Internet markets. The issue was raised in the AOL-Time Warner merger. There, federal officials approved the merger only after winning "open access" guarantees. These required the new merged entity to give rival Internet Service Providers equal access to the merged company's cable lines (representing about 20 percent of the U.S. market) and not to discriminate on the basis of affiliation in the transmission of content.
But many worry the terms of merger approval will prove insufficient. AOL Time Warner is a major cable operator. It maintains a huge library of proprietary "content" -- including magazines, movies, cartoons and music. And AOL exerts control over tens of millions of people's access to the Internet through proprietary software. The strong incentive is for AOL Time Warner to leverage its control of the conduit of information -- via cable lines and Internet connections -- to favor its content at the expense of others. This could be done, for example, through technological deployments that lead consumers to first see AOL Time Warner programming or which slow delivery of rival content, among other techniques; or by refusing to distribute or charging more for rival television network programming (favoring CNN over Fox News or MSNBC, for example).
The government's approach in the AOL Time Warner case was an example of applying a case-by-case approach to deal with issues from vertical integration.
In a recent decision, the FCC dealt with a similar conduit/content concern by preserving a blanket rule. This rule did not proscribe vertical integration, but it prohibited exclusive dealing and imposed a form of compulsory licensing of TV programming. The matter dealt with vertically integrated programmers -- cable providers like AOL Time Warner which also provide programming. The concern was that these vertically integrated operations might refuse to license their programming to other cable providers and to satellite broadcasters. A refusal to license desired programming like CNN would induce consumers to purchase cable services from AOL Time Warner as opposed to cable providers that would be unable to air CNN. The rule retained by the FCC requires companies like AOL Time Warner to license programming like CNN on a nonexclusive basis to competitor cable companies and to satellite broadcasters.
In upholding the rule, the FCC concluded "vertically integrated programmers generally retain the incentive and ability to favor their cable affiliates over nonaffiliated cable operators and other competitive multichannel video programming distributors to such a degree that, in the absence of the prohibition, competition and diversity in the distribution of video programming would not be preserved or protected."
But the FCC's decision to retain the rule bucked the trend. Both the FCC and U.S. federal regulators in general are increasingly hostile to the idea of regulation to prohibit or tightly regulate cross-industry ownership arrangements.
However, apart from the political difficulties of adopting, protecting or enforcing such restrictions, a major difficulty with focusing on restrictions on vertical integration is that rules need to be tailored on an industry-by-industry basis. Although broad antitrust principles can be devised or reinvigorated to prohibit, for all industries, certain kinds of conduct and leveraging of market power from one industry into another, these then require case-by-case application to see if a company's conduct violates specific conduct rules. A more structural approach, barring designated types of vertical integration altogether, can only be done with an eye to the specific characteristics of particular industries. In other words, there's no easy way to boil down this approach.
But that complexity cannot be a reason to leave the terrain to the corporate interests which are fast repealing the few restrictions on vertical ownership still on the books. These structural approaches work in fundamental ways to delimit the sphere of permissible corporate activity. In many cases, they do or could confer major public benefits.
And it is possible to explain the concepts through illustrative anecdote. The financial scandals make the point. So the does the behavior of Clear Channel. And almost everyone can understand that you don't want your prescribing doctor to have a financial interest in the pharmacy where you buy your medicines.