The Law and Economics of Horizontal Mergers

Incentives to Merge Merger to attain monopoly Merger for Improved efficiency Takeovers

The Williamson Tradeoff D AC 1 AC 2 Q2Q2 Q1Q1 P2P2 P1P1 A B $/Q Q

The Economic effects of Mergers Theoretical Considerations Dominant Firm-Competitive Fringe Cournot Bertrand Empirical Analyses Event analyses (Eckbo; Prager) Merger Specific Analyses (Northwest-Republic)

Implications of DF-CF Model for Mergers If a dominant firm mergers with a competitive fringe firm, market power and price will rise (ceteris paribus) The magnitude of market power increases depend on standard DF-CF Market power factors (concentration; fringe SS elasticity, market DD elasticity) Without barriers to entry, no MP increase Efficiency gains may offset market power effects

Northwest/Republic Merger Markup Relative to industry average prices (%) NW +Rep + Other NW or Republic + Other NW + REP NW or Rep

Merger Policy in Practice Legal foundation of merger policy Clayton Act, Section 7 Hart Scott Rodino Antitrust enforcement Judicial Treatment of mergers

The Clayton Act, Section 7 That no corporation engaged in commerce shall acquire, directly or indirectly, the whole or any part…of another corporation also engaged in commerce, where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly. * in any line of commerce in any section of the country *the effect…may be to lessen competition or tend to create Language matters….

Hart Scott Rodino Requires pre-notification of intent to merger be filed with both the Federal Trade Commission and the Department of Justice, Antitrust Division The relevant antitrust agency has 30 days to green light or issue a “second request” Second requests typical involve large detailed filing Once complete DOJ/FTC has 20 days

2010 Merger Guidelines “The unifying theme of the Guidelines is that mergers should not be permitted to create, enhance or entrench market power or to facilitate its exercise.”

The DOJ/FTC Merger Guidelines Market Definition Market concentration Entry Conditions Other Competitive Indicators Merger-induced efficiencies

Market Definition Begin with a small geographic and product definition. Could a hypothetical monopolist raise prices by a small but significant and non-transitory amount? Yes No (dd-side product, dd-side geographic, ss-side product, ss-side geographic substitutability)

Market Concentration Herfindahl-Hirschmann Index HHI = Σ S 2 i 0<HHI<10,000 (Post merger) HHI < unconcentrated 1500 <HHI< moderately concentrated if ΔHHI <100 if ΔHHI > <HHI -- highly concentrated If 100< ΔHHI <200 “potentially raise significant competitive concerns” if ΔHHI >200 “presumed to be likely to enhance market power”

Entry conditions Prior taxonomy: Uncommited Entry Committed entry Entry requiring significant sunk costs “The Agencies will consider the actual history of entry into the relevant market and give substantial weight to this evidence.” Timely (“former language” w/i two years; now “rapid enough…”) Likely (profitable at pre-merger prices), and Sufficient (enough to discipline prices)

Other Competitive Indicators Would merger facilitate collusion? Facilitate monitoring of cheating Promote ability to punish cheaters Factors: e.g., product homogeneity; are transactions prices “visible”; are demand and cost changing rapidly; maverick firm

Merger-Induced Efficiencies Consistent with Williamson Trade-off Only considered if merger is only means of achieving efficiencies Consider the case of efficiencies to gain economies of scale...

Brown Shoe Company v. U.S. Merger of Brown and Kinney shoes (retail) market: product markets: mens, womens, childrens’ geographic : any city over 10,000 “We cannot avoid the mandate of Congress that tendencies toward concentration in industry are to be curbed in their incipiency”

FTC v. Coca-Cola Coca-Cola - Dr. Pepper, Pepsi - 7-Up announce merger plans FTC issues preliminary injunction Coca-Cola-Dr. Pepper challenge in court Critical issue: Market definition FTC - carbonated soft drinks (pricing decisions of executives) Coca-Cola - all potable liquids sold in North America (Lake Erie defense)

FTC v. Coca-Cola (cont.) Barriers to entry sunk costs of entry (brand name awareness) requirements for distribution network limited buttons on “Coke Machines” Anticipated anticompetitive effects Third party bottler problem Court’s finding “the acquisition totally lacks any apparent redeeming feature.”