Basic economic theory underlies the conventional antitrust wisdom that if a merger makes the merging party a more effective competitorby lowering its costs, rivals facing this more effective competitor post-merger are made worse off, but consumers benefit. On the other hand, if a merger is likely to result in collusion or a unilateral price increase, the rival firm is made better off while consumers suffer. In the latter case — the one the DOJ complaint asserts we are experiencing with respect to the proposed AT&T merger — marketwide coordination or reduction of competition resulting in higher prices makes the non-merging rival better off.
Basic economic theory thus generates a set of clear testable implications for the DOJ’s theory of the transaction:
- (1) events that the merger more likely should have a negative impact upon non-merging rivals’ stock prices when the merger is procompetitive (reflecting the likelihood the firm will face a more efficient, lower-cost rival in the future);
- (2) events that make a merger less likely should have a positive impact upon non-merging rivals’ stock prices when the merger is procompetitive (reflecting the reduced likelihood that the merger will face the more efficient competitor in the future)
- (3) by similar economic logic, events that make an anticompetitive merger more likely to occur should result in increase non-merging rivals’ stock prices (who will benefit from higher market prices) while events that make an anticompetitive merger less likely should decrease non-merging rivals’ stock prices.
The DOJ complaint clearly stakes out its position that the merger will be anticompetitive, and result in higher market prices. Paragraph 36 of the DOJ’s complaint focuses upon potential post-merger coordination:
The substantial increase in concentration that would result from this merger, and the reduction in the number of nationwide providers from four to three, likely will lead to lessened competition due to an enhanced risk of anticompetitive coordination. … Any anti competitive coordination at a national level would result in higher nationwide prices (or other nationwide harm) by the remaining national providers, Verizon, Sprint, and the merged entity. Such harm would affect consumers all across the nation, including those in rural areas with limited T-Mobile presence.
Paragraph 37 of the DOJ complaint turns to unilateral effects:
The proposed merger likely would lessen competition through elimination of head-to-head competition between AT&T and T-Mobile. … The proposed merger would, therefore, likely eliminate important competition between AT&T and T-Mobile.
If the DOJ’s allegations are correct, one would expect the market price for prominent non-merging rivals such as Sprint to fall upon today’s announcement that the DOJ will challenge the merger. This is because the announcement decreases the likelihood that an anticompetitive merger will occur, and thus deprives the opportunity for non-merging rivals to enjoy the increased market prices and margins that would follow from post-merger collusion or unilateral price increases.
The NY Times Dealbook headline suggests otherwise: “Sprint Shares Surge on AT&T Setback.” Geoff highlighted several of the DOJ’s claims in the report. As the case unfolds, I think an important question to ask is how many of those allegations are consistent with the following data showing the market reactions of Sprint and Clearwire stock prices today. I’ve included Clearwire both because Sprint owns a majority share in it and because of its recent announcement of plans to enter the 4G LTE space.
I’ve not run a full-blown event study here, obviously. But the positive jump for Sprint (Blue Line) & Clearwire (Green Line) today in response to the announcement is hard to miss. How many of the statements in the DOJ complaint, press release and analysis are consistent with this market reaction? If the post-merger market would be less competitive than the status quo, as the DOJ complaint hypothesizes, why would the market reward Sprint and Clearwire for an increased likelihood of facing greater competition in the future? The simplest alternative hypothesis is that the merger is likely procompetitive and rivals are enjoying a premium for the increased likelihood that they will avoid more intense competition in the future. Is there a reason here to reject that simple hypothesis? Will the market reaction induce the DOJ to revisit its priors?
Why did you choose Sprint particularly? Verizon, a larger and far more significant competitor, had its stock drop sharply in that same period you show Sprint “surging”. MetroPCS’s stock also dropped.
So what does it mean when a weak competitor’s stock jumps but two other competitors who are doing well have their stock drop? Other than that there are clearly more factors in play here?
Josh, maybe you could walk me through this. Why wouldn’t the market’s reaction be a sign of this: (a) the AT&T/T-Mobile merger will give the new entity strong market power, (b) there are strong anticompetitive as well as efficiency gains from being bigger and having more market size, (c) the newly merged company would use that power to crush its weakest competitors, i.e. Sprint? After all, isn’t there a traditional story where monopolists cut prices to drive other competitors out, but then gradually raise price once their market power allows it, especially in industries with high barriers to entry?
Isn’t another simple hypothesis that investors think that what is bad for ATT/T-Mobile is good for Sprint? That a combined Att/T-Mobile might in the long run threaten the existence of Sprint?
Might also have something to do with the stiff breakup fee that AT&T is contractually obligated to pay if the merger falls through.
Josh, the Wall St. Journal today reports that the stock of the smaller competitors MetroPCS and Leap/Cricket did go down following the DOJ announcement, as did Verizon’s (albeit only slightly) and that some investment analysts predicted that blocking the merger would be bad for the entire industry because it would be “structurally less attractive than it would otherwise have been” (i.e. more competitive). Although the smaller carriers may gain in the short run due from a merger that raises prices, they also may lose in the long run due to its exclusionary effects, a theory that was front and center of Sprint’s opposition (and the smaller carriers’). Notably Verizon, which has no reason to fear exclusion and would have the most to lose if the merger were actually efficient, has not opposed the merger. In an FCC filing, the American Antitrust Institute pointed out that in the two days after the merger was announced, Verizon’s stock jumped 3.1% compared to the S&P 500’s increase of only 1.1%. See AAI’s reply comments at http://www.antitrustinstitute.org (June 20, 2011). The bottom line is that insofar as stock price movements reflect investors’ view of the likely competitive consequences of a merger, the evidence here is mixed at best.
Best regards, Rick Brunell
Everything Josh says is correct – assuming market competition is the relevant or only kind of competition. But what if the more significant kind of competition now is for political favor and the larger company (i.e. after the merger) is in a better position to get favorable treatment vis-avis its competitors, say, through firm-specificly favorable regulation? Should the Courts take this kind of competition into account when construing the anti-merger laws?
Henry — if the exclusive or most relevant type (it is, of course, relevant) of competition was post-merger competition for favorable regulatory treatment relative to rivals one would expect the merger to generate negative abnormal returns for rivals such as Verizon, Metro, and Sprint relative to the status quo, and that effect would be especially present for the smaller firms (your theory is that the larger company is in a better position to get more favorable treatment). Thus, one would expect the challenge announcement to generate positive abnormal returns inversely proportional to rival size, i.e. Verizon should gain the least, next Sprint, then the smaller carriers like Metro and Leap. However, Sprint’s gains are very large relative to the reaction of the smaller carriers. To be clear, as I mention in my follow up post, I think the challenge signals that future Verizon mergers would be challenged as well is part of the story here.
As to whether the Courts should take anticipated regulatory capture into account when construing the Clayton Act, I guess my view is getting federal judges to incorporate an economic theory of mergers aimed at consumer welfare is hard enough — adding a theory of political competition, I suspect, would end up imposing a significant tax on consumer welfare and efficiency in practice.