Economics of Regulation

1
Economics of Regulation

• Mergers and Acquisitions

2
Definitions

• Merger - transaction that results in a wholly new
  firm.
• Acquisition - transaction in which one firm is
  absorbed by another.

3
Horizontal/ Vertical/ Conglomerate Mergers

• Stages of production - raw materials, refining,
  finished good, wholesale, retail.
• Horizontal mergers - between two firms in the
  same stage of production.
• Vertical mergers - between firms in different
  (usually adjacent) stages of production. Backward
  integration when a firm merges with one of its
  suppliers. Forward integration when a firm
  mergers with one of its customers.

4
Conglomerate mergers

• Between firms that have little or nothing to do
  with each other.
• A. Product extension merger - acquiring firm is a
  multiple-product firm that fills out its product
  line in a natural way by acquiring an established
  brand of the added commodity.
• B. Market Extension merger involves firms in the
  same industry but not in the same geographic
  market.
• C. Pure conglomerate - nothing to do with each
  other.

5
Motives for MA

• Antiefficiency Motives
• Acquiring monopoly power - merger instead of
  colluding vertical mergers can foreclose
  markets. Ex. Brown Shoe buying Kinney Shoe
• Empire building by managers - prestige, job
  security, pay.

6
Motives for MA

• Avoiding Taxes
• A. Debt over equity financing. Interest is
  deductible dividends are not.
• B. Revalue assets and increase depreciation
  allowances
• Profits to merger promoters (Wall Street Broker
  firms earn lots for advising on mergers)

7
Motives for MA

• Proefficiency Motives
• Economies of scale, scope, synergies (Job losses)
• Disciplining corporate management
• Diversification and bargain hunting
• Preventing opportunism involved specialized
  assets. RR to mine

8
Antitrust Laws

• Section 7 of Clayton Act limits mergers that may
  lessen competition. Loopholes (stock vs. Physical
  assets).
• Celler-Kefauver Act amended Clayton act to
  include any that would "lessen competition or
  tend to create a monopoly in any line of commerce
  in any section of the country."
• Hart-Scott-Rodino Act requires FTC and Justice
  Department to review mergers and contest or
  require more information.

9
Horizontal Merger Guidelines

• 1968 guidelines
• In markets with four-firm CR gt 75 percent
  challenge if acquiring firm's market share gt 15
  and target is gt 1.
• In markets with four-firm CR lt 75 challenge if
  acquiring firm's market share is gt 30 and target
  is gt 1.

10
Horizontal Merger Guidelines

• 1982/84 guidelines (see JEP Fall 1987)
• Herfindahl index used.
• Structural factors examined - ease of entry
  turnover rates market growth

11
Horizontal Merger Guidelines

• Relevant market uses 5 percent test If 5 percent
  price hike causes many buyers to purchase certain
  substitutes, these products are counted in the
  relevant market.
• Cost saving or efficiencies might be used to
  justify mergers that would otherwise be ruled
  illegal.

12
Horizontal Merger Guidelines
13
Horizontal Merger Guidelines

• Additional Factors
• Is entry difficult?
• Are products homogeneous?
• Are substitutes inferior?
• Is there a history of collusion in the market?
• Is acquired firm a disruptive competitor?
• Is market noncompetitive?
• If no, challenge is unlikely.
• If yes, challenge is likely.