Three Types of Inefficiency in Strategic Offers: Empirical Identification from Merger Remedy Settlements Luke Garrod, Bruce Lyons and Andrei Medvedev

The institutions of EC remedy agreement provide a natural experiment to test theory of strategic offers INTRODUCTION If both parties are rational and have complete information, mutually beneficial agreement will… definitely be reached and be reached immediately Incomplete information can explain some delay… screening for others type signalling of own type Evidence from… experiments labour bargaining EC remedy agreements involve… bargaining strategy from firms more passive competition agency

The institutions of EC remedy agreement provide a natural experiment to test theory of strategic offers INTRODUCTION Two parties - Competition agency and merging firms Discrete rounds (2-phase investigation) More information gathered in phase II Allows early (phase I) or late agreement (phase II)… or no agreement Legally specified… Time limits to each phase (i.e. limited evidence gathering) Order of who can make offers and who can accept/reject Agency decision must be based on evidence Three types of error… Type 1 – remedy too stringent Type 2 – remedy insufficient to prevent market power Type 3 – remedy agreed late

We present a theoretical model based on Lyons and Medvedev (2007) which allows us to predict which types of errors will occur and when EMPIRICAL PREDICTIONS Delay to Phase II more likely if: Complex or imprecise merger appraisal (high σ1) Delay is relatively less costly to the firms (K/π) Model does not predict any effect of: Obvious harm of the merger (αT) Remedies in phase I: Too stringent (Type 1 error) if issues are simple and/or delay is costly to firms Insufficient (Type 2 error) if issues are complex and/or delay is not costly Remedies in phase II are: Late (Type 3 error) if issues are simple and/or delay is costly to firms

We collected data from mergers with remedies agreed for horizontal aspects in phase I and phase II during the period THE VARIABLES

Phase II documents tend to be more complete and detailed compared to those produced for phase I decisions. Without the correct attention, this could lead to bias. POTENTIAL BIAS The bias in the dataset can be highlighted by the entry barriers variable Another bias: only cursory analysis for simple markets in phase II documents… … filter used to eliminate markets not usually discussed in phase II documents

At low levels, the market share filter removes mostly markets that do not cause competition concerns MARKETS REMOVED

If there is no bias we would expect the market share filter to removed a proportion of (1340/2084=) phase I markets from the dataset PROPORTION REMOVED

Sample size is n = 130… 30 other mergers are not included in the dataset due to lack of data or because they raised predominantly vertical issues DESCRIPTIVE STATISTICS

Sample size is n = 130… 30 other mergers are not included in the dataset due to lack of data or because they raised predominantly vertical issues DESCRIPTIVE STATISTICS

Probit Analysis shows what factors affect the likelihood that a merger will fail to be agreed in phase I PROBIT ANALYSIS

Probit Analysis shows what factors affect the likelihood that a merger will fail to be agreed in phase I FURTHER SPECIFICATION

Probit Analysis shows what factors affect the likelihood that a merger will fail to be agreed in phase I MARGINAL EFFECTS

Our results are not dependent upon the level of the market share filter, as the results are relatively robust for a number of different filters (including 0%) SENSITIVITY ANALYSIS

The theory suggests Type 1 errors are likely occur when probability of phase II is low and Type 2 are likely to occur when probability of phase II is high TYPE 1 AND 2 ERRORS

All phase II mergers are Type 3 errors but those with a low probability of phase II are likely to be explained by poor strategic play as opposed to complexity and delay cost TYPE 3 ERRORS

We present a theoretical model based on Lyons and Medvedev (2007) which allows us to predict which types of errors will occur and when CONCLUSIONS Delay in reaching agreement arises when: competition issues are complex and delay is costly to the firms Theory suggests: Remedies in phase I: Too stringent (Type 1 error) if issues are simple and/or delay is costly to firms Insufficient (Type 2 error) if issues are complex and/or delay is not costly Remedies in phase II are: Late (Type 3 error) if issues are simple and/or delay is costly to firms Empirics back up the theory and suggest: Type 1 errors are more common than Type 2 errors Type 3 errors also occur from poor strategic actions from players

Here are the 'top five' mergers for each error type that, according to our analysis, are most likely to be errors TOP FIVES