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MergersEmphasisonhorizontalmergers

Importanceofmergers

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Notablerecentdeals

3Source:Wikipedia

Industriesarereshaped

•  BigPharmaintroubles– Patentsexpire– LowR&Dproductivity

•  M&Apattern1998-2012(top20companies)–  991transactionsbetween1998and2012

(Source:CEPTONStrategies)

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Aggregateactivity

SwedishGDP2013ca550billionUSD

http://www.statista.com/statistics/267369/volume-of-mergers-and-acquisitions-worldwide/

Conclusion

•  Mergeractivity–  Individualdealsaresubstantial– Entireindustriesarereshaped– Aggregatevolumeishuge

•  Insum– Mergersreshape/adapteconomy

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Motivesformergers

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Motive1:Efficiencies

•  Horizontalcoordination– Economiesofscaleandscope:e.g.centralpurchasing– Rationalization:producepartswherecheapest

•  Verticalcoordination– Avoidholdupofinvestments

•  Takeoverofunderutilizedassets

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Motive1:Efficiencies

•  Anefficiency“externality”– Marketforcorporatecontrol– Takeoverofunderutilizedassets– Threatoftakeoverimportantdiscipliningforceonmanagements

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Motive2:Marketpower

•  Horizontaleffects– Definition:Betweencompetitors– Problem:Unilateralorcoordinated

•  Verticaleffects– Definition:Betweenbuyerandseller– Problem:Foreclosure

•  Conglomerateeffects– Definition:Between“unrelated”firms– Problem:probablynone

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Othermotivesformergers

•  Managementdriven– Managementprestige(empirebuilding)– Hubris

•  Industrialpolicy– “Nationalchampions”–prestige– Employment

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BasicElementsofMergersPolicy

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RichardWhish&DavidBailey:CompetitionLaw,SeventhEdition,OxfordUniversityPress,2012.

Goals

•  Consumerwelfare– Anticompetitiveeffects– Costefficiency,butonlyifbeneficialtoconsumers

•  Disregard– Employment– Nationalsecurity?

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Meaningof“merger”

•  Definitionof“concentration”– Previouslyindependentbusinessescomeundercommoncontrol

•  Examples– Acquisitionofminorityshareholdingmaybesufficient,ifitgives“decisiveinfluence”

– Acquisitionofassets(ex:plants,brands,patents)– Mergerofpartsofbusinessesintojointventure

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Notification

•  MergerswithCommunitydimensionpre-notifiedtoCommission– Combinedworldwideturnover>€5000mn– EU-wideturnover>€250mnofeachcompany

•  Otherbigmergerspre-notifiedtoMemberState

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Notification

•  Extra-territorial– Doesnotmatterifallcompaniesaree.g.American

•  One-stop-shop– MergerswithCommunitydimensioncannotbetriedbyMemberStates

– Still,manybigmergershavetobenotifiedto10–20differentcompetitionauthorities

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Notification

•  Notificationcontainsinformationone.g.– Affectedmarkets(preliminarymarketdefinitionsbytheparties)

– Partiesmarketshares– HHI

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Decisionrights

•  EU– Commissiondecides– Firmscanappealtocourts

•  Sweden– KKV=“prosecutor”– Courtsdecide

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Timelimits

•  PhaseI– 25workingdays

•  PhaseII(3%ofcases)– 90workingdays

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Competitiontest

•  Now:“Significantimpedimentofcompetition”– Typically:createsorstrengthensdominantposition(=highlevelofmarketpower)

–  Includes:•  Singlefirmdominance=“similartomonopoly”•  Jointdominance=“similartocartel”•  Butalsoregularoligopoly

•  Previously:Dominance– Unclearifregularoligopolywasincluded

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Competitiontest

•  Definemarkets– Productmarket/geographicalmarkets

•  Estimateeffectoncompetition– Marketsharesandconcentration(veryimportant)– Diversionratios(=measureofsubstitutability)– Strengthofbrand(awell-knownbrandismorelikelytobepeople’ssecondchoice)

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Competitiontest

•  Presumption:Noproblemif– Partiesmarketshare<25%– Post-mergerHHI<1000– Post-mergerHHI<2000&ΔHHI<250– ΔHHI<150

•  Recall– HHImax=10000(=1002)– 1000=tensymmetricfirms(=10x102)

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EntryandBuyerPower

•  Entry– Likely=assessmentofentrybarriers– Timely=normallywithin2years– Sufficient=eliminatepriceincrease

•  Buyerpower– Sizeofbuyer– Abilitytointegrate– Sponsorupstreamentry

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Efficiencies

•  Benefitconsumers–  Lowerprices

•  Largereductionsinmarginalcost•  Incentivetopasson

– Neworimprovedproducts

•  Mergerspecific–  Cannotbeachievedwithoutreductionincompetition

•  Verifiability–  FirmsmustbeabletoensureCommission

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Failingfirmdefense

•  Noimpedimenttocompetitionif– Onefirmwouldbecomebankrupt– Assetswouldexitthemarket– Nolessanti-competitivealternativetothemerger

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Remedies

•  Usualsolutionsolutionifproblems•  Typesofremedies

– Divestitureofoverlappingbusinesses– Accesstoanessentialfacility– Licensingoftechnology

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Evidence

•  Burdenofproof– Commissionhasburdentoprove

•  Anti-competitiveeffects•  Nobuyerpower•  Noentry

– Firmshaveburdentoprove•  Efficiencies•  Failingfirmdefense

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Evidence

•  Differentstandardsofproof– “Onthebalanceofprobabilities”or– “Beyondreasonabledoubt”

•  Mergerpolicy– Convincingevidence(=balanceofprobabilities,ifIunderstanditright)

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Statistics1990-2017

•  Notifications:6522•  OK

– PhaseI:5803– PhaseII:62

•  Interventions– Withdrawn:177– OKwithcommitments:121– Prohibitions:26

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Useofeconomicsinmergerpolicy

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Theoryofcompetitiveharm

•  Fundamentaldifficulty– Assessingnotifiedmergers=predictingthefuture– Mustbuildoneconomictheory– Competitionauthoritiesmustpresentatheoryofcompetitiveharmineverycase

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Theoryofcompetitiveharm

•  Theoryofcompetitiveharm– Unilateraleffects– Coordinatedeffects– Verticaleffects

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Counterfactual

•  Effect=Differencebetween– Marketoutcomewithmerger– Marketoutcomewithoutmerger=Counterfactual

•  Possiblecounterfactuals– Mostoften:StatusQuo– Sometimes:Failingfirm– Possible:Alternativemergers(Volvo/Scania)

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Economicevidence

•  Competitionauthoritymustpresentevidenceinsupportofits“theoryofharm”

•  Examplesofsophisticatedeconomics– Estimationofcross-priceelasticities– Pricecorrelations– Mergersimulations

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WelfareTradeoff(somedetails)

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Unilateraleffects

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Twoaspects

–  “Internalization”

•  Mergingfirms’initialincentivetoincreaseprices

•  Tostudythisincentiveassumethatcompetitorskeeptheirpricesfixed

–  Outsiderresponse

•  Competitors’reactiontoinitialpricechange

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Internalization

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Internalization

•  Increasedpricebeforemerger+  Increasedmarkup(pA–cA)-  Somecustomersleavethemarket-  SomecustomersbuyproductBinstead

•  Increasedpriceaftermerger+  Increasedmarkup(pA–cA)-  Somecustomersleavethemarket0  SomecustomersbuyproductBinstead

Ø  Morebeneficialtoincreaseprice

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Internalization

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Before mergerπ A = pA − cA( ) ⋅DA pA , pB( )

FOC∂π A

∂pA= DA pA , pB( ) + pA − cA( ) ∂DA

∂pA= 0

Internalization

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After mergerπ A + π B = pA − cA( ) ⋅DA pA , pB( ) + pB − cB( ) ⋅DB pA , pB( )

FOC∂π A + π B

∂pA= DA pA , pB( ) + pA − cA( ) ∂DA

∂pA+ pB − cB( ) ∂DB

∂pA= 0

Internalization

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Before merger∂πA

∂pA= DA pA , pB( ) + pA − cA( )∂DA

∂pA= 0

After merger∂πA + πB

∂pA= DA pA , pB( ) + pA − cA( )∂DA

∂pA+ pB − cB( )∂DB

∂pA= 0

Q:WhatistheeffectofmergeronpA?ExplainhowyoucandeducethisfromFOC

Internalization

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Before merger∂πA

∂pA= DA pA , pB( ) + pA − cA( )∂DA

∂pA= 0

After merger∂πA + πB

∂pA= DA pA , pB( ) + pA − cA( )∂DA

∂pA+ pB − cB( )∂DB

∂pA= 0

At old equilibrium price:

∂πA + πB

∂pA= pB − cB( )∂DB

∂pA> 0

Internalization

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At old equilibrium price:

∂πA + πB

∂pA= pB − cB( )∂DB

∂pA> 0

Strength of effectMarket power before merger : pB − cB( )

How close competitors are A and B : ∂DB

∂pA

Internalization

•  DiversionRatio(fromAtoB)-  Definition:Howmuchofthedisplaceddemand

forproductAswitchestoproductB,whenthepriceofAisincreased

-  Intuitive:FractionofproductA:sconsumerswhohaveproductBasasecondchoice

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δAB ≡ −pB ⋅

∂DB

∂pApA ⋅

∂DA

∂pA

∈ 0,1[ ]

Internalization

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After merger∂π A + π B

∂pA= DA pA , pB( ) + pA − cA( ) ∂DA

∂pA+ pB − cB( ) ∂DB

∂pA= 0

pA − cApA

⎛⎝⎜

⎞⎠⎟−

pB − cBpB

⎛⎝⎜

⎞⎠⎟δAB = −

1εAA

SymmetrypA − cApA

= −1εAA

11− δAB

Hence

ΔpA − cApA

= −1εAA

⎛⎝⎜

⎞⎠⎟

δAB

1− δAB

⎛⎝⎜

⎞⎠⎟

Internalization

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After merger∂π A + π B

∂pA= DA pA , pB( ) + pA − cA( ) ∂DA

∂pA+ pB − cB( ) ∂DB

∂pA= 0

pA − cApA

⎛⎝⎜

⎞⎠⎟−

pB − cBpB

⎛⎝⎜

⎞⎠⎟δAB = −

1εAA

SymmetrypA − cApA

= −1εAA

11− δAB

Hence

ΔpA − cApA

= −1εAA

⎛⎝⎜

⎞⎠⎟

δAB

1− δAB

⎛⎝⎜

⎞⎠⎟

Marketpowerincreasesmuchif� Demandelasticitylow(highmarketpoweralreadybeforemerger)� Diversionratiohigh(productsclosesubstitutescomparedtootherproducts)

Outsiders’Response

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Outsiders’Response

•  Response-  Insidersincreasepriceandreduceoutput-  Outsiders’residualdemandincrease-  Outsidersrespondby

•  Increasingprice•  Increasingoutput

•  Keyissue–  Willoutsidersmainlyincreasepriceoroutput?

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Outsiders’Response

•  Outsidersincreaseoutputmuchif-  Outsiders’conductcompetitive

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Outsiders’Response

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Mergerincreasescompetitors’residualdemand

Outsiders’Response

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Intensecompetitionamongoutsiders-perfectcompetition-Bertrand

Outsiders’Response

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Outsider=monopolyorcartel

Outsiders’Response

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Ifoutsidershavemorecompetitiveconduct,theyexpandoutputmoreinreactiontoincreaseinresidualdemand

Outsiders’Response

•  Outsidersincreaseoutputmuchif-  Outsiders’conductcompetitive-  Outsiders’costslow-  Outsidershavenocapacityconstraints-  Easytoswitchbetweengeographicalmarkets-  Entrycostslow

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UnilateralEffect

•  Twoaspects–  Internalization

•  Increaseprice&reduceoutput

–  Outsiders’response•  Increaseprice&increaseoutput

–  Needformalmodeltostudybothatthesametime

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Efficiencies

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Efficiencies

•  Rationalization-  Reallocateproductiontoefficientplants

•  Economiesofscale-  Avoidduplicationofvariousactivities-  Coordinationofnewinvestments-  Specialization-lengthenproductionruns

•  Technologicalprogress-  Poolingexistingknow-how-  CoordinateR&D

•  Reducingslack-  Replaceinefficientmanagement

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Efficiencies

•  Butmergersmayalsocauseinefficiencies-  Lesscompetitionmayleadtomoreslack

-  Largerorganizationmaybemoredifficulttocontrol

-  Problemsmeltingculturestogether

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Totalwelfareandconsumerwelfare

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Totalwelfare

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pd=cd

pm(cd)

MergerfromBertrandduopolytoMonopoly

1

2

Totalwelfare

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A

cd

pm(cd)

cm

pm(cm)

B

1

23

CostsavingA=LessresourcesconsumedB=Eliminatespartofdwlcausedbymerger

Totalwelfare

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pd=cd

pm(cd)

cm

pm(cm)

1

3

Sufficientlylargereductioninmarginalcostoffsetsthedeadweightlossduetomonopoly

Totalwelfare

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pd=cd

pm(cd)

cm

pm(cm)

Ifyouknowthemarketdata,theminimumrequiredcostreductioncanbecomputed

Consumerwelfare

•  Pricemaygodown

•  ΔMCmustbelarge

•  Marginalcost,notfixed

•  Canbecomputed,ifweknowdemand

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pd=cd

cm

pm(cm)

Economicissuesinmergerpolicy

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Issues•  Appropriategoal

–  Consumerwelfarestandard–  Totalwelfare

•  Ismergercontrolnecessary?–  Anticompetitivemergersoftenunprofitable–  Bettertobeoutsider–  Otherpolicies:abuseofdominance;fightcartels

•  Canmergerpolicybeevaluated,I–  Deterrenceofanticompetitivemergers=>onlygoodor“marginally

bad”mergersproposed–  Deterrencecannotbeobserved

•  Canmergerpolicybeevaluated,II–  Cannotobservetheeffectsofblockedmergers–  Counter-argument:eventstudies

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