Mergers: theory and practice

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Mergers theory and practice 1. Horizontal
mergers Unilateral effects Merger increases
market power Efficiency gains Pro-collusive
(or coordinated) effects How to proceed A
"check-list 2. Vertical mergers 3. EU Merger
Regulation 4. Merger remedies in the EU
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Horizontal mergers unilateral effects (One-shot
Nash equilibrium before and after the
merger.) If there are no efficiency gains,
merging firms increase prices consumer
and total surplus decrease. Intuitions, and
Figures 5.1 and 5.2
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If there are no efficiency gains (cont.) The
merger increases outsiders' profits. (This
result does not depend on whether firms compete
on prices or quantities.) The merger increases
producer surplus. The merger reduces net
welfare.
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Efficiency gains If savings from the merger are
large enough, they will outweigh the increase in
market power and result in lower
prices. Assessment of efficiency
gains. Distinction between cost savings that
affect variable costs (and prices), and cost
savings that affect fixed costs. Efficiencies
from technical rationalisation are easier to
demonstrate. Efficiencies should be
merger-specific (Farrell-Shapiro only synergies
- i.e. intimate integration of firms assets,
not mere reorganisation of output among
facilities). Independent studies to
evaluate efficiency considerations.
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Efficiency gains from mergers (cont.) The merger
is beneficial to consumers if and only if it
involves enough efficiency gains (see Figure
5.3) It increases outsiders' profits if
efficiency gains are small enough (NB
Incentives for outsiders to complain when there
are efficiency gains!) The merger always
increases producer surplus The merger improves
net welfare if it involves enough efficiency gains
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Horizontal mergers pro-collusive effects The
merger might create the structural conditions for
the firms to (tacitly or explicitly)
collude. Two main reasons. Reduced number
of firms. More symmetric distribution of
assets.
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• How to proceed in horizontal mergers a
  check-list
• Unilateral effects
• Market definition
• Product and geographic market
• Market power
• Market shares and distribution of capacities
  demand elasticities elasticity of supply of
  rivals potential entrants switching costs
  buyer power
• If possible, econometric analysis.
• Efficiency gains

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Two possible outcomes 1. The merger
enables firms to significantly raise


prices beyond the current
level. Prohibition or remedies. 2. Might
collusion arise after the merger?
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Joint dominance

• Number of firms and concentration
• Distribution of market shares and capacities
• Potential entrants (and switching costs)
• Buyers' power
• Observability of other firms' behaviour (exchange
  of information, competition clauses, resale price
  maintenance)
• Frequency of market transactions and magnitude of
  orders.

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Vertical mergers

• When two firms at successive production stages
  merge.
• Possible efficiency effects from vertical
  integration
• Avoiding double marginalisation problems
• Generally, avoiding (or reducing, since agency
  problems might still exist) vertical
  externalities, as joint control of upstream and
  downstream firms
• Avoiding opportunistic behaviour and promote
  specific investments
• Better coordination of investments and
  innovations

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Vertical mergers Possible exclusionary effects?

• If an upstream monopolist integrates downstream,
  would it foreclose input to downstream rivals?
• Chicago School No foreclosure effects, because
  of Single Monopoly Profit theory
• (SMP theory if downstream firms are perfectly
  competitive, all profits from the vertical
  industry can be reaped by the input monopolist
  no incentive to merge for foreclosure)
• Modern IO yes, foreclosure might be both
  feasible and profitable, e.g. because of the
  commitment problem (Hart-Tirole)

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Two-step analysis of vertical foreclosure

• Step 1. Does the vertical merger harm downstream
  rivals? (does the input price paid by them rise?)
• a. Will integrated firm cease to supply? (raise
  input prices?) No, if downstream rivals serve
  different markets and/or other efficient upstream
  firms exist
• b. Assume integrated firm ceases to supply. Input
  price paid by downstream rivals will not
  necessarily rise (i) other upstream firms might
  increase supply (ii) lower demand for input
  (downstream affiliate withdraws from input
  market) tends to reduce prices

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Two-step analysis of vertical foreclosure, II

• If foreclosure will occur (if not, investigation
  stops)
• Step 2. Does the vertical merger harm
  competition? (i.e., which final effect on
  welfare?)
• a. Because of removal of double marginalisation
  problems, downstream affiliate will tend to
  reduce prices
• b. If downstream rivals pay higher input price,
  but are competitive enough, difficult for
  downstream affiliate to raise prices even if it
  wanted
• c. If indeed vertical firm has market power, this
  may be balanced by efficiencies from vertical
  integration

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EU Merger Policy

• Preventive authorisation system (originally MTF,
  but recent re-organisation)
• One-stop shop for mergers (subsidiarity
  principle)
• Reasonably quick and effective, with certain
  time horizon

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Source European Merger Control - Council
Regulation 4064/89 - Statistics
Figure 5.4.1. Number of final decision on mergers
taken by the EC Commission
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Source European Merger Control - Council
Regulation 4064/89 - Statistics
Figure 5.4.2. Number of final decision on mergers
taken by the EC Commission
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Source European Merger Control - Council
Regulation 4064/89 - Statistics
Figure 5.4.3. Number of final decision on mergers
taken by the EC Commission
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The EU Merger Regulation 4064/89 was source of
inefficient biases. 1) Restricting attention to
mergers which create dominance implies that some
welfare detrimental mergers might be
approved. (Joint dominance to cover unilateral
effects not a good approach. Airtours
judgment.) 2) Failure to consider efficiency
gains might result in beneficial mergers being
blocked by the EU authorities.
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New Merger Regulation

• Compromise between dominance and SLC test.
• It prohibits mergers that would significantly
  impede effective competition, in the common
  market or in a substantial part of it, in
  particular as a result of the creation or
  strengthening of a dominant position.
• Merger guidelines clarify DG-COMPs approach to
  mergers.
• (They also include an efficiency defence.)

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Merger remedies in the EU

• Merger remedies increasingly important in the EU
  and US
• Structural remedies they include divestiture of
  an entire ongoing business or partial divestiture
  (possibly a mix and match of assets of the
  different firms involved.
• Non-structural remedies engagements not to
  abuse of certain assets available to them,
  including compulsory licensing or access to
  property rights.

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1. Structural remedies

• Structural remedies preferred commitment if
  feasible.
• Divestiture plan must offer a package of tangible
  and intangible assets, supply and sales
  agreements, customer lists, third party service
  agreements, technical assistance etc., so that
  new entity is viable.
• Identity of buyers relevant to assess the
  viability of the new entity the EC may require
  to find an up-front buyer
• An existing competitor in the same or in adjacent
  markets can be preferred as a purchaser of the
  divested assets it has market knowledge and
  experience (but possible joint dominance problems)

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2. Non-structural remedies

• If divestiture unfeasible (e.g., due to vertical
  links or compl. products) non-structural
  remedies
• Purely behavioural commitment to give non
  discriminatory access of key inputs to
  competitors
• Es. Vodafone Airtouch/Mannesmann 3-years
  access to the integrated mobile telephone network
• Vivendi/Canal / Seagram a 5-years ceiling to
  the Universal production rights granted to Canal
  
• Contractual commitment to license a technology
  to rivals.
• Astra/Zeneca a 10-years grant to an independent
  distributor of the main alternative betablocker.

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Non-structural remedies (cont.)

• Vertical Firewalls commitment to segment the
  information flaws within the company
• Problems with non-structural remedies
• They require specialized knowledge of the
  industry
• They require ongoing commitment of resources of
  the authority during the long implementation
  phase.