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AT&T’s $102 billion acquisition of Time Warner in 2019 will go down in M&A history as an exceptionally ill-advised transaction, resulting in the loss of tens of billions of dollars of shareholder value. It should also go down in history as an exceptional ill-chosen target of antitrust intervention.  The U.S. Department of Justice, with support from many academic and policy commentators, asserted with confidence that the vertical combination of these content and distribution powerhouses would result in an entity that could exercise market power to the detriment of competitors and consumers.

The chorus of condemnation continued with vigor even after the DOJ’s loss in court and AT&T’s consummation of the transaction. With AT&T’s May 17 announcement that it will unwind the two-year-old acquisition and therefore abandon its strategy to integrate content and distribution, it is clear these predictions of impending market dominance were unfounded. 

This widely shared overstatement of antitrust risk derives from a simple but fundamental error: regulators and commentators were looking at the wrong market.  

The DOJ’s Antitrust Case against the Transaction

The business case for the AT&T/Time Warner transaction was straightforward: it promised to generate synergies by combining a leading provider of wireless, broadband, and satellite television services with a leading supplier of video content. The DOJ’s antitrust case against the transaction was similarly straightforward: the combined entity would have the ability to foreclose “must have” content from other “pay TV” (cable and satellite television) distributors, resulting in adverse competitive effects. 

This foreclosure strategy was expected to take two principal forms. First, AT&T could temporarily withhold (or threaten to withhold) content from rival distributors absent payment of a higher carriage fee, which would then translate into higher fees for subscribers. Second, AT&T could permanently withhold content from rival distributors, who would then lose subscribers to AT&T’s DirectTV satellite television service, further enhancing AT&T’s market power. 

Many commentators, both in the trade press and significant portions of the scholarly community, characterized the transaction as posing a high-risk threat to competitive conditions in the pay TV market. These assertions reflected the view that the new entity would exercise a bottleneck position over video-content distribution in the pay TV market and would exercise that power to impose one-sided terms to the detriment of content distributors and consumers. 

Notwithstanding this bevy of endorsements, the DOJ’s case was rejected by the district court and the decision was upheld by the D.C. appellate court. The district judge concluded that the DOJ had failed to show that the combined entity would exercise any credible threat to withhold “must have” content from distributors. A key reason: the lost carriage fees AT&T would incur if it did withhold content were so high, and the migration of subscribers from rival pay TV services so speculative, that it would represent an obviously irrational business strategy. In short: no sophisticated business party would ever take AT&T’s foreclosure threat seriously, in which case the DOJ’s predictions of market power were insufficiently compelling to justify the use of government power to block the transaction.

The Fundamental Flaws in the DOJ’s Antitrust Case

The logical and factual infirmities of the DOJ’s foreclosure hypothesis have been extensively and ably covered elsewhere and I will not repeat that analysis. Following up on my previous TOTM commentary on the transaction, I would like to emphasize the point that the DOJ’s case against the transaction was flawed from the outset for two more fundamental reasons. 

False Assumption #1

The assumption that the combined entity could withhold so-called “must have” content to cause significant and lasting competitive injury to rival distributors flies in the face of market realities.  Content is an abundant, renewable, and mobile resource. There are few entry barriers to the content industry: a commercially promising idea will likely attract capital, which will in turn secure the necessary equipment and personnel for production purposes. Any rival distributor can access a rich menu of valuable content from a plethora of sources, both domestically and worldwide, each of which can provide new content, as required. Even if the combined entity held a license to distribute purportedly “must have” content, that content would be up for sale (more precisely, re-licensing) to the highest bidder as soon as the applicable contract term expired. This is not mere theorizing: it is a widely recognized feature of the entertainment industry.

False Assumption #2

Even assuming the combined entity could wield a portfolio of “must have” content to secure a dominant position in the pay TV market and raise content acquisition costs for rival pay TV services, it still would lack any meaningful pricing power in the relevant consumer market. The reason: significant portions of the viewing population do not want any pay TV or only want dramatically “slimmed-down” packages. Instead, viewers increasingly consume content primarily through video-streaming services—a market in which platforms such as Amazon and Netflix already enjoyed leading positions at the time of the transaction. Hence, even accepting the DOJ’s theory that the combined entity could somehow monopolize the pay TV market consisting of cable and satellite television services, the theory still fails to show any reasonable expectation of anticompetitive effects in the broader and economically relevant market comprising pay TV and streaming services.  Any attempt to exercise pricing power in the pay TV market would be economically self-defeating, since it would likely prompt a significant portion of consumers to switch to (or start to only use) streaming services.

The Antitrust Case for the Transaction

When properly situated within the market that was actually being targeted in the AT&T/Time Warner acquisition, the combined entity posed little credible threat of exercising pricing power. To the contrary, the combined entity was best understood as an entrant that sought to challenge the two pioneer entities—Amazon and Netflix—in the “over the top” content market.

Each of these incumbent platforms individually had (and have) multi-billion-dollar content production budgets that rival or exceed the budgets of major Hollywood studios and enjoy worldwide subscriber bases numbering in the hundreds of millions. If that’s not enough, AT&T was not the only entity that observed the displacement of pay TV by streaming services, as illustrated by the roughly concurrent entry of Disney’s Disney+ service, Apple’s Apple TV+ service, Comcast NBCUniversal’s Peacock service, and others. Both the existing and new competitors are formidable entities operating in a market with formidable capital requirements. In 2019, Netflix, Amazon, and Apple TV expended approximately $15 billion, $6 billion, and again, $6 billion, respectively, on content; by contrast, HBO Max, AT&T’s streaming service, expended approximately $3.5 billion. 

In short, the combined entity faced stiff competition from existing and reasonably anticipated competitors, requiring several billions of dollars on “content spend” to even stay in the running. Far from being able to exercise pricing power in an imaginary market defined by DOJ litigators for strategic purposes, the AT&T/Time Warner entity faced the challenge of merely surviving in a real-world market populated by several exceptionally well-financed competitors. At best, the combined entity “threatened” to deliver incremental competitive benefits by adding a robust new platform to the video-streaming market; at worst, it would fail in this objective and cause no incremental competitive harm. As it turns out, the latter appears to be the case.

The Enduring Virtues of Antitrust Prudence

AT&T’s M&A fiasco has important lessons for broader antitrust debates about the evidentiary standards that should be applied by courts and agencies when assessing alleged antitrust violations, in general, and vertical restraints, in particular.  

Among some scholars, regulators, and legislators, it has become increasingly received wisdom that prevailing evidentiary standards, as reflected in federal case law and agency guidelines, are excessively demanding, and have purportedly induced chronic underenforcement. It has been widely asserted that the courts’ and regulators’ focus on avoiding “false positives” and the associated costs of disrupting innocuous or beneficial business practices has resulted in an overly cautious enforcement posture, especially with respect to mergers and vertical restraints.

In fact, these views were expressed by some commentators in endorsing the antitrust case against the AT&T/Time-Warner transaction. Some legislators have gone further and argued for substantial amendments to the antitrust law to provide enforcers and courts with greater latitude to block or re-engineer combinations that would not pose sufficiently demonstrated competitive risks under current statutory or case law.

The swift downfall of the AT&T/Time-Warner transaction casts great doubt on this critique and accompanying policy proposals. It was precisely the district court’s rigorous application of those “overly” demanding evidentiary standards that avoided what would have been a clear false-positive error. The failure of the “blockbuster” combination to achieve not only market dominance, but even reasonably successful entry, validates the wisdom of retaining those standards.

The fundamental mismatch between the widely supported antitrust case against the transaction and the widely overlooked business realities of the economically relevant consumer market illustrates the ease with which largely theoretical and decontextualized economic models of competitive harm can lead to enforcement actions that lack any reasonable basis in fact.   

In the battle of ideas, it is quite useful to be able to brandish clear and concise debating points in support of a proposition, backed by solid analysis. Toward that end, in a recent primer about antitrust law published by the Mercatus Center, I advance four reasons to reject neo-Brandeisian critiques of the consensus (at least, until very recently) consumer welfare-centric approach to antitrust enforcement. My four points, drawn from the primer (with citations deleted and hyperlinks added) are as follows:

First, the underlying assumptions of rising concentration and declining competition on which the neo-Brandeisian critique is largely based (and which are reflected in the introductory legislative findings of the Competition and Antitrust Law Enforcement Reform Act [of 2021, introduced by Senator Klobuchar on February 4, lack merit]. Chapter 6 of the 2020 Economic Report of the President, dealing with competition policy, summarizes research debunking those assumptions. To begin with, it shows that studies complaining that competition is in decline are fatally flawed. Studies such as one in 2016 by the Council of Economic Advisers rely on overbroad market definitions that say nothing about competition in specific markets, let alone across the entire economy. Indeed, in 2018, professor Carl Shapiro, chief DOJ antitrust economist in the Obama administration, admitted that a key summary chart in the 2016 study “is not informative regarding overall trends in concentration in well-defined relevant markets that are used by antitrust economists to assess market power, much less trends in concentration in the U.S. economy.” Furthermore, as the 2020 report points out, other literature claiming that competition is in decline rests on a problematic assumption that increases in concentration (even assuming such increases exist) beget softer competition. Problems with this assumption have been understood since at least the 1970s. The most fundamental problem is that there are alternative explanations (such as exploitation of scale economies) for why a market might demonstrate both high concentration and high markups—explanations that are still consistent with procompetitive behavior by firms. (In a related vein, research by other prominent economists has exposed flaws in studies that purport to show a weakening of merger enforcement standards in recent years.) Finally, the 2020 report notes that the real solution to perceived economic problems may be less government, not more: “As historic regulatory reform across American industries has shown, cutting government-imposed barriers to innovation leads to increased competition, strong economic growth, and a revitalized private sector.”

Second, quite apart from the flawed premises that inform the neo-Brandeisian critique, specific neo-Brandeisian reforms appear highly problematic on economic grounds. Breakups of dominant firms or near prohibitions on dominant firm acquisitions would sacrifice major economies of scale and potential efficiencies of integration, harming consumers without offering any proof that the new market structures in reshaped industries would yield consumer or producer benefits. Furthermore, a requirement that merging parties prove a negative (that the merger will not harm competition) would limit the ability of entrepreneurs and market makers to act on information about misused or underutilized assets through the merger process. This limitation would reduce economic efficiency. After-the-fact studies indicating that a large percentage of mergers do not add wealth and do not otherwise succeed as much as projected miss this point entirely. They ignore what the world would be like if mergers were much more difficult to enter into: a world where there would be lower efficiency and dynamic economic growth because there would be less incentive to seek out market-improving opportunities.

Third, one aspect of the neo-Brandeisian approach to antitrust policy is at odds with fundamental notions of fair notice of wrongdoing and equal treatment under neutral principles, notions that are central to the rule of law. In particular, the neo-Brandeisian call for considering a multiplicity of new factors such as fairness, labor, and the environment when enforcing policy is troublesome. There is no neutral principle for assigning weights to such divergent interests, and (even if weights could be assigned) there are no economic tools for accurately measuring how a transaction under review would affect those interests. It follows that abandoning antitrust law’s consumer-welfare standard in favor of an ill-defined multifactor approach would spawn confusion in the private sector and promote arbitrariness in enforcement decisions, undermining the transparency that is a key aspect of the rule of law. Whereas concerns other than consumer welfare may of course be validly considered in setting public policy, they are best dealt with under other statutory schemes, not under antitrust law.

Fourth, and finally, neo-Brandeisian antitrust proposals are not a solution to widely expressed concerns that big companies in general, and large digital platforms in particular, are undermining free speech by censoring content of which they disapprove. Antitrust law is designed to prevent businesses from creating impediments to market competition that reduce economic welfare; it is not well-suited to policing companies’ determinations regarding speech. To the extent that policymakers wish to address speech censorship on large platforms, they should consider other regulatory institutions that would be better suited to the task (such as communications law), while keeping in mind First Amendment limitations on the ability of government to control private speech.

In light of these four points, the primer concludes that the neo-Brandeisian-inspired antitrust “reform” proposals being considered by Congress should be rejected:

[E]fforts to totally reshape antitrust policy into a quasi-regulatory system that arbitrarily blocks and disincentivizes (1) welfare-enhancing mergers and (2) an array of actions by dominant firms are highly troubling. Such interventionist proposals ignore the lack of evidence of serious competitive problems in the American economy and appear arbitrary compared to the existing consumer-welfare-centric antitrust enforcement regime. To use a metaphor, Congress and public officials should avoid a drastic new antitrust cure for an anticompetitive disease that can be handled effectively with existing antitrust medications.

Let us hope that the serious harm associated with neo-Brandeisian legislative “deformation” (a more apt term than reformation) of the antitrust laws is given a full legislative airing before Congress acts.

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the legal and regulatory issues that arose during Ajit Pai’s tenure as chairman of the Federal Communications Commission. The entire series of posts is available here.

Geoffrey A. Manne is the president and founder of the International Center for Law and Economics.]

I’m delighted to add my comments to the chorus of voices honoring Ajit Pai’s remarkable tenure at the Federal Communications Commission. I’ve known Ajit longer than most. We were classmates in law school … let’s just say “many” years ago. Among the other symposium contributors I know of only one—fellow classmate, Tom Nachbar—who can make a similar claim. I wish I could say this gives me special insight into his motivations, his actions, and the significance of his accomplishments, but really it means only that I have endured his dad jokes and interminable pop-culture references longer than most. 

But I can say this: Ajit has always stood out as a genuinely humble, unfailingly gregarious, relentlessly curious, and remarkably intelligent human being, and he deployed these characteristics to great success at the FCC.   

Ajit’s tenure at the FCC was marked by an abiding appreciation for the importance of competition, both as a guiding principle for new regulations and as a touchstone to determine when to challenge existing ones. As others have noted (and as we have written elsewhere), that approach was reflected significantly in the commission’s Restoring Internet Freedom Order, which made competition—and competition enforcement by the antitrust agencies—the centerpiece of the agency’s approach to net neutrality. But I would argue that perhaps Chairman Pai’s greatest contribution to bringing competition to the forefront of the FCC’s mandate came in his work on media modernization.

Fairly early in his tenure at the commission, Ajit raised concerns with the FCC’s failure to modernize its media-ownership rules. In response to the FCC’s belated effort to initiate the required 2010 and 2014 Quadrennial Reviews of those rules, then-Commissioner Pai noted that the commission had abdicated its responsibility under the statute to promote competition. Not only was the FCC proposing to maintain a host of outdated existing rules, but it was also moving to impose further constraints (through new limitations on the use of Joint Sales Agreements (JSAs)). As Ajit noted, such an approach was antithetical to competition:

In smaller markets, the choice is not between two stations entering into a JSA and those same two stations flourishing while operating completely independently. Rather, the choice is between two stations entering into a JSA and at least one of those stations’ viability being threatened. If stations in these smaller markets are to survive and provide many of the same services as television stations in larger markets, they must cut costs. And JSAs are a vital mechanism for doing that.

The efficiencies created by JSAs are not a luxury in today’s digital age. They are necessary, as local broadcasters face fierce competition for viewers and advertisers.

Under then-Chairman Tom Wheeler, the commission voted to adopt the Quadrennial Review in 2016, issuing rules that largely maintained the status quo and, at best, paid tepid lip service to the massive changes in the competitive landscape. As Ajit wrote in dissent:

The changes to the media marketplace since the FCC adopted the Newspaper-Broadcast Cross-Ownership Rule in 1975 have been revolutionary…. Yet, instead of repealing the Newspaper-Broadcast Cross-Ownership Rule to account for the massive changes in how Americans receive news and information, we cling to it.

And over the near-decade since the FCC last finished a “quadrennial” review, the video marketplace has transformed dramatically…. Yet, instead of loosening the Local Television Ownership Rule to account for the increasing competition to broadcast television stations, we actually tighten that regulation.

And instead of updating the Local Radio Ownership Rule, the Radio-Television Cross-Ownership Rule, and the Dual Network Rule, we merely rubber-stamp them.

The more the media marketplace changes, the more the FCC’s media regulations stay the same.

As Ajit also accurately noted at the time:

Soon, I expect outside parties to deliver us to the denouement: a decisive round of judicial review. I hope that the court that reviews this sad and total abdication of the administrative function finds, once and for all, that our media ownership rules can no longer stay stuck in the 1970s consistent with the Administrative Procedure Act, the Communications Act, and common sense. The regulations discussed above are as timely as “rabbit ears,” and it’s about time they go the way of those relics of the broadcast world. I am hopeful that the intervention of the judicial branch will bring us into the digital age.

And, indeed, just this week the case was argued before the Supreme Court.

In the interim, however, Ajit became Chairman of the FCC. And in his first year in that capacity, he took up a reconsideration of the 2016 Order. This 2017 Order on Reconsideration is the one that finally came before the Supreme Court. 

Consistent with his unwavering commitment to promote media competition—and no longer a minority commissioner shouting into the wind—Chairman Pai put forward a proposal substantially updating the media-ownership rules to reflect the dramatically changed market realities facing traditional broadcasters and newspapers:

Today we end the 2010/2014 Quadrennial Review proceeding. In doing so, the Commission not only acknowledges the dynamic nature of the media marketplace, but takes concrete steps to update its broadcast ownership rules to reflect reality…. In this Order on Reconsideration, we refuse to ignore the changed landscape and the mandates of Section 202(h), and we deliver on the Commission’s promise to adopt broadcast ownership rules that reflect the present, not the past. Because of our actions today to relax and eliminate outdated rules, broadcasters and local newspapers will at last be given a greater opportunity to compete and thrive in the vibrant and fast-changing media marketplace. And in the end, it is consumers that will benefit, as broadcast stations and newspapers—those media outlets most committed to serving their local communities—will be better able to invest in local news and public interest programming and improve their overall service to those communities.

Ajit’s approach was certainly deregulatory. But more importantly, it was realistic, well-reasoned, and responsive to changing economic circumstances. Unlike most of his predecessors, Ajit was unwilling to accede to the torpor of repeated judicial remands (on dubious legal grounds, as we noted in our amicus brief urging the Court to grant certiorari in the case), permitting facially and wildly outdated rules to persist in the face of massive and obvious economic change. 

Like Ajit, I am not one to advocate regulatory action lightly, especially in the (all-too-rare) face of judicial review that suggests an agency has exceeded its discretion. But in this case, the need for dramatic rule change—here, to deregulate—was undeniable. The only abuse of discretion was on the part of the court, not the agency. As we put it in our amicus brief:

[T]he panel vacated these vital reforms based on mere speculation that they would hinder minority and female ownership, rather than grounding its action on any record evidence of such an effect. In fact, the 2017 Reconsideration Order makes clear that the FCC found no evidence in the record supporting the court’s speculative concern.

…In rejecting the FCC’s stated reasons for repealing or modifying the rules, absent any evidence in the record to the contrary, the panel substituted its own speculative concerns for the judgment of the FCC, notwithstanding the FCC’s decades of experience regulating the broadcast and newspaper industries. By so doing, the panel exceeded the bounds of its judicial review powers under the APA.

Key to Ajit’s conclusion that competition in local media markets could be furthered by permitting more concentration was his awareness that the relevant market for analysis couldn’t be limited to traditional media outlets like broadcasters and newspapers; it must include the likes of cable networks, streaming video providers, and social-media platforms, as well. As Ajit put it in a recent speech:

The problem is a fundamental refusal to grapple with today’s marketplace: what the service market is, who the competitors are, and the like. When assessing competition, some in Washington are so obsessed with the numerator, so to speak—the size of a particular company, for instance—that they’ve completely ignored the explosion of the denominator—the full range of alternatives in media today, many of which didn’t exist a few years ago.

When determining a particular company’s market share, a candid assessment of the denominator should include far more than just broadcast networks or cable channels. From any perspective (economic, legal, or policy), it should include any kinds of media consumption that consumers consider to be substitutes. That could be TV. It could be radio. It could be cable. It could be streaming. It could be social media. It could be gaming. It could be still something else. The touchstone of that denominator should be “what content do people choose today?”, not “what content did people choose in 1975 or 1992, and how can we artificially constrict our inquiry today to match that?”

For some reason, this simple and seemingly undeniable conception of the market escapes virtually all critics of Ajit’s media-modernization agenda. Indeed, even Justice Stephen Breyer in this week’s oral argument seemed baffled by the notion that more concentration could entail more competition:

JUSTICE BREYER: I’m thinking of it solely as a — the anti-merger part, in — in anti-merger law, merger law generally, I think, has a theory, and the theory is, beyond a certain point and other things being equal, you have fewer companies in a market, the harder it is to enter, and it’s particularly harder for smaller firms. And, here, smaller firms are heavily correlated or more likely to be correlated with women and minorities. All right?

The opposite view, which is what the FCC has now chosen, is — is they want to move or allow to be moved towards more concentration. So what’s the theory that that wouldn’t hurt the minorities and women or smaller businesses? What’s the theory the opposite way, in other words? I’m not asking for data. I’m asking for a theory.

Of course, as Justice Breyer should surely know—and as I know Ajit Pai knows—counting the number of firms in a market is a horrible way to determine its competitiveness. In this case, the competition from internet media platforms, particularly for advertising dollars, is immense. A regulatory regime that prohibits traditional local-media outlets from forging efficient joint ventures or from obtaining the scale necessary to compete with those platforms does not further competition. Even if such a rule might temporarily result in more media outlets, eventually it would result in no media outlets, other than the large online platforms. The basic theory behind the Reconsideration Order—to answer Justice Breyer—is that outdated government regulation imposes artificial constraints on the ability of local media to adopt the organizational structures necessary to compete. Removing those constraints may not prove a magic bullet that saves local broadcasters and newspapers, but allowing the rules to remain absolutely ensures their demise. 

Ajit’s commitment to furthering competition in telecommunications markets remained steadfast throughout his tenure at the FCC. From opposing restrictive revisions to the agency’s spectrum screen to dissenting from the effort to impose a poorly conceived and retrograde regulatory regime on set-top boxes, to challenging the agency’s abuse of its merger review authority to impose ultra vires regulations, to, of course, rolling back his predecessor’s unsupportable Title II approach to net neutrality—and on virtually every issue in between—Ajit sought at every turn to create a regulatory backdrop conducive to competition.

Tom Wheeler, Pai’s predecessor at the FCC, claimed that his personal mantra was “competition, competition, competition.” His greatest legacy, in that regard, was in turning over the agency to Ajit.

One of the key recommendations of the House Judiciary Committee’s antitrust report which seems to have bipartisan support (see Rep. Buck’s report) is shifting evidentiary burdens of proof to defendants with “monopoly power.” These recommended changes are aimed at helping antitrust enforcers and private plaintiffs “win” more. The result may well be more convictions, more jury verdicts, more consent decrees, and more settlements, but there is a cost. 

Presumption of illegality for certain classes of defendants unless they can prove otherwise is inconsistent with the American traditions of the presumption of innocence and allowing persons to dispose of their property as they wish. Forcing antitrust defendants to defend themselves from what is effectively a presumption of guilt will create an enormous burden upon them. But this will be felt far beyond just antitrust defendants. Consumers who would have benefited from mergers that are deterred or business conduct that is prevented will have those benefits foregone.

The Presumption of Liberty in American Law

The Presumption of Innocence

There is nothing wrong with presumptions in law as a general matter. For instance, one of the most important presumptions in American law is that criminal defendants are presumed innocent until proven guilty. Prosecutors bear the burden of proof, and must prove guilt beyond a reasonable doubt. Even in the civil context, plaintiffs, whether public or private, have the burden of proving a violation of the law, by the preponderance of the evidence. In either case, the defendant is not required to prove they didn’t violate the law.

Fundamentally, the presumption of innocence is about liberty. As William Blackstone put it in his Commentaries on the Law of England centuries ago: “the law holds that it is better that ten guilty persons escape than that one innocent suffer.” 

In economic terms, society must balance the need to deter bad conduct, however defined, with not deterring good conduct. In a world of uncertainty, this includes the possibility that decision-makers will get it wrong. For instance, if a mere allegation of wrongdoing places the burden upon a defendant to prove his or her innocence, much good conduct would be deterred out of fear of false allegations. In this sense, the presumption of innocence is important: it protects the innocent from allegations of wrongdoing, even if that means in some cases the guilty escape judgment.

Presumptions in Property, Contract, and Corporate Law

Similarly, presumptions in other areas of law protect liberty and are against deterring the good in the name of preventing the bad. For instance, the presumption when it comes to how people dispose of their property is that unless a law says otherwise, they may do as they wish. In other words, there is no presumption that a person may not use their property in a manner they wish to do so. The presumption is liberty, unless a valid law proscribes behavior. The exceptions to this rule typically deal with situations where a use of property could harm someone else. 

In contracts, the right of persons to come to a mutual agreement is the general rule, with rare exceptions. The presumption is in favor of enforcing voluntary agreements. Default rules in the absence of complete contracting supplement these agreements, but even the default rules can be contracted around in most cases.

Bringing the two together, corporate law—essentially the nexus of contract law and property law— allows persons to come together to dispose of property and make contracts, supplying default rules which can be contracted around. The presumption again is that people are free to do as they choose with their own property. The default is never that people can’t create firms to buy or sell or make agreements.

A corollary right of the above is that people may start businesses and deal with others on whatever basis they choose, unless a generally applicable law says otherwise. In fact, they can even buy other businesses. Mergers and acquisitions are generally allowed by the law. 

Presumptions in Antitrust Law

Antitrust is a generally applicable set of laws which proscribe how people can use their property. But even there, the presumption is not that every merger or act by a large company is harmful. 

On the contrary, antitrust laws allow groups of people to dispose of property as they wish unless it can be shown that a firm has “market power” that is likely to be exercised to the detriment of competition or consumers. Plaintiffs, whether public or private, bear the burden of proving all the elements of the antitrust violation alleged.

In particular, antitrust law has incorporated the error cost framework. This framework considers the cost of getting decisions wrong. Much like the presumption of innocence is based on the tradeoff of allowing some guilty persons to go unpunished in order to protect the innocent, the error cost framework notes there is tradeoff between allowing some anticompetitive conduct to go unpunished in order to protect procompetitive conduct. American antitrust law seeks to avoid the condemnation of procompetitive conduct more than it avoids allowing the guilty to escape condemnation. 

For instance, to prove a merger or acquisition would violate the antitrust laws, a plaintiff must show the transaction will substantially lessen competition. This involves defining the market, that the defendant has power over that market, and that the transaction would lessen competition. While concentration of the market is an important part of the analysis, antitrust law must consider the effect on consumer welfare as a whole. The law doesn’t simply condemn mergers or acquisitions by large companies just because they are large.

Similarly, to prove a monopolization claim, a plaintiff must establish the defendant has “monopoly power” in the relevant market. But monopoly power isn’t enough. As stated by the Supreme Court in Trinko:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period— is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

The plaintiff must also prove the defendant has engaged in the “willful acquisition or maintenance of [market] power, as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident.” Antitrust law is careful to avoid mistaken inferences and false condemnations, which are especially costly because they “chill the very conduct antitrust laws are designed to protect.”

The presumption isn’t against mergers or business conduct even when those businesses are large. Antitrust law only condemns mergers or business conduct when it is likely to harm consumers.

How Changing Antitrust Presumptions will Harm Society

In light of all of this, the House Judiciary Committee’s Investigation of Competition in Digital Markets proposes some pretty radical departures from the law’s normal presumption in favor of people disposing property how they choose. Unfortunately, the minority report issued by Representative Buck agrees with the recommendations to shift burdens onto antitrust defendants in certain cases.

One of the recommendations from the Subcommittee is that Congress:

“codify[] bright-line rules for merger enforcement, including structural presumptions. Under a structural presumption, mergers resulting in a single firm controlling an outsized market share, or resulting in a significant increase in concentration, would be presumptively prohibited under Section 7 of the Clayton Act. This structural presumption would place the burden of proof upon the merging parties to show that the merger would not reduce competition. A showing that the merger would result in efficiencies should not be sufficient to overcome the presumption that it is anticompetitive. It is the view of Subcommittee staff that the 30% threshold established by the Supreme Court in Philadelphia National Bank is appropriate, although a lower standard for monopsony or buyer power claims may deserve consideration by the Subcommittee. By shifting the burden of proof to the merging parties in cases involving concentrated markets and high market shares, codifying the structural presumption would help promote the efficient allocation of agency resources and increase the likelihood that anticompetitive mergers are blocked. (emphasis added)

Under this proposal, in cases where concentration meets an arbitrary benchmark based upon the market definition, the presumption will be that the merger is illegal. Defendants will now bear the burden of proof to show the merger won’t reduce competition, without even getting to refer to efficiencies that could benefit consumers. 

Changing the burden of proof to be against criminal defendants would lead to more convictions of guilty people, but it would also lead to a lot more false convictions of innocent defendants. Similarly, changing the burden of proof to be against antitrust defendants would certainly lead to more condemnations of anticompetitive mergers, but it would also lead to the deterrence of a significant portion of procompetitive mergers.

So yes, if adopted, plaintiffs would likely win more as a result of these proposed changes, including in cases where mergers are anticompetitive. But this does not necessarily mean it would be to the benefit of larger society. 

Antitrust has evolved over time to recognize that concentration alone is not predictive of likely competitive harm in merger analysis. Both the horizontal merger guidelines and the vertical merger guidelines issued by the FTC and DOJ emphasize the importance of fact-specific inquiries into competitive effects, and not just a reliance on concentration statistics. This reflected a long-standing bipartisan consensus. The HJC’s majority report overturns this consensus by suggesting a return to the structural presumptions which have largely been rejected in antitrust law.

The HJC majority report also calls for changes in presumptions when it comes to monopolization claims. For instance, the report calls on Congress to consider creating a statutory presumption of dominance by a seller with a market share of 30% or more and a presumption of dominance by a buyer with a market share of 25% or more. The report then goes on to suggest overturning a number of precedents dealing with monopolization claims which in their view restricted claims of tying, predatory pricing, refusals to deal, leveraging, and self-preferencing. In particular, they call on Congress to “[c]larify[] that ‘false positives’ (or erroneous enforcement) are not more costly than ‘false negatives’ (erroneous non-enforcement), and that, when relating to conduct or mergers involving dominant firms, ‘false negatives’ are costlier.”

This again completely turns the ordinary presumptions about innocence and allowing people to dispose of the property as they see fit on their head. If adopted, defendants would largely have to prove their innocence in monopolization cases if their shares of the market are above a certain threshold. 

Moreover, the report calls for Congress to consider making conduct illegal even if it “can be justified as an improvement for consumers.” It is highly likely that the changes proposed will harm consumer welfare in many cases, as the focus changes from economic efficiency to concentration. 

Conclusion

The HJC report’s recommendations on changing antitrust presumptions should be rejected. The harms will be felt not only by antitrust defendants, who will be much more likely to lose regardless of whether they have violated the law, but by consumers whose welfare is no longer the focus. The result is inconsistent with the American tradition that presumes innocence and the ability of people to dispose of their property as they see fit. 

Germán Gutiérrez and Thomas Philippon have released a major rewrite of their paper comparing the U.S. and EU competitive environments. 

Although the NBER website provides an enticing title — “How European Markets Became Free: A Study of Institutional Drift” — the paper itself has a much more yawn-inducing title: “How EU Markets Became More Competitive Than US Markets: A Study of Institutional Drift.”

Having already critiqued the original paper at length (here and here), I wouldn’t normally take much interest in the do-over. However, in a recent episode of Tyler Cowen’s podcast, Jason Furman gave a shout out to Philippon’s work on increasing concentration. So, I thought it might be worth a review.

As with the original, the paper begins with a conclusion: The EU appears to be more competitive than the U.S. The authors then concoct a theory to explain their conclusion. The theory’s a bit janky, but it goes something like this:

  • Because of lobbying pressure and regulatory capture, an individual country will enforce competition policy at a suboptimal level.
  • Because of competing interests among different countries, a “supra-national” body will be more independent and better able to foster pro-competitive policies and to engage in more vigorous enforcement of competition policy.
  • The EU’s supra-national body and its Directorate-General for Competition is more independent than the U.S. Department of Justice and Federal Trade Commission.
  • Therefore, their model explains why the EU is more competitive than the U.S. Q.E.D.

If you’re looking for what this has to do with “institutional drift,” don’t bother. The term only shows up in the title.

The original paper provided evidence from 12 separate “markets,” that they say demonstrated their conclusion about EU vs. U.S. competitiveness. These weren’t really “markets” in the competition policy sense, they were just broad industry categories, such as health, information, trade, and professional services (actually “other business sector services”). 

As pointed out in one of my earlier critiques, In all but one of these industries, the 8-firm concentration ratios for the U.S. and the EU are below 40 percent and the HHI measures reported in the original paper are at levels that most observers would presume to be competitive. 

Sending their original markets to drift in the appendices, Gutiérrez and Philippon’s revised paper focuses its attention on two markets — telecommunications and airlines — to highlight their claims that EU markets are more competitive than the U.S. First, telecoms:

To be more concrete, consider the Telecom industry and the entry of the French Telecom company Free Mobile. Until 2011, the French mobile industry was an oligopoly with three large historical incumbents and weak competition. … Free obtained its 4G license in 2011 and entered the market with a plan of unlimited talk, messaging and data for €20. Within six months, the incumbents Orange, SFR and Bouygues had reacted by launching their own discount brands and by offering €20 contracts as well. … The relative price decline was 40%: France went from being 15% more expensive than the US [in 2011] to being 25% cheaper in about two years [in 2013].

While this is an interesting story about how entry can increase competition, the story of a single firm entering a market in a single country is hardly evidence that the EU as a whole is more competitive than the U.S.

What Gutiérrez and Philippon don’t report is that from 2013 to 2019, prices declined by 12% in the U.S. and only 8% in France. In the EU as a whole, prices decreased by only 5% over the years 2013-2019.

Gutiérrez and Philippon’s passenger airline story is even weaker. Because airline prices don’t fit their narrative, they argue that increasing airline profits are evidence that the U.S. is less competitive than the EU. 

The picture above is from Figure 5 of their paper (“Air Transportation Profits and Concentration, EU vs US”). They claim that the “rise in US concentration and profits aligns closely with a controversial merger wave,” with the vertical line in the figure marking the Delta-Northwest merger.

Sure, profitability among U.S. firms increased. But, before the “merger wave,” profits were negative. Perhaps predatory pricing is pro-competitive after all.

Where Gutiérrez and Philippon really fumble is with airline pricing. Since the merger wave that pulled the U.S. airline industry out of insolvency, ticket prices (as measured by the Consumer Price Index), have decreased by 6%. In France, prices increased by 4% and in the EU, prices increased by 30%. 

The paper relies more heavily on eyeballing graphs than statistical analysis, but something about Table 2 caught my attention — the R-squared statistics. First, they’re all over the place. But, look at column (1): A perfect 1.00 R-squared. Could it be that Gutiérrez and Philippon’s statistical model has (almost) as many parameters as variables?

Notice that all the regressions with an R-squared of 0.9 or higher include country fixed effects. The two regressions with R-squareds of 0.95 and 0.96 also include country-industry fixed effects. It’s very possible that the regressions results are driven entirely by idiosyncratic differences among countries and industries. 

Gutiérrez and Philippon provide no interpretation for their results in Table 2, but it seems to work like this, using column (1): A 10% increase in the 4-firm concentration ratio (which is different from a 10 percentage point increase), would be associated with a 1.8% increase in prices four years later. So, an increase in CR4 from 20% to 22% (or an increase from 60% to 66%) would be associated with a 1.8% increase in prices over four years, or about 0.4% a year. On the one hand, I just don’t buy it. On the other hand, the effect is so small that it seems economically insignificant. 

I’m sure Gutiérrez and Philippon have put a lot of time into this paper and its revision. But there’s an old saying that the best thing about banging your head against the wall is that it feels so good when it stops. Perhaps, it’s time to stop with this paper and let it “drift” into obscurity.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]

While much of the world of competition policy has focused on mergers in the COVID-19 era. Some observers see mergers as one way of saving distressed but valuable firms. Others have called for a merger moratorium out of fear that more mergers will lead to increased concentration and market power. In the meantime, there has been a growing push for increased nationalization of a wide range of businesses and industries.

In most cases, the call for a government takeover is not a reaction to the public health and economic crises associated with coronavirus. Instead, COVID-19 is a convenient excuse to pursue long sought after policies.

Last year, well before the pandemic, New York mayor Bill de Blasio called for a government takeover of electrical grid operator ConEd because he was upset over blackouts during a heatwave. Earlier that year, he threatened to confiscate housing units from private landlords, “we will seize their buildings, and we will put them in the hands of a community nonprofit that will treat tenants with the respect they deserve.”

With that sort of track record, it should come as no surprise the mayor proposed a government takeover of key industries to address COVID-19: “This is a case for a nationalization, literally a nationalization, of crucial factories and industries that could produce the medical supplies to prepare this country for what we need.” Dana Brown, director of The Next System Project at The Democracy Collaborative, agrees, “We should nationalize what remains of the American vaccine industry now, thereby assuring that any coronavirus vaccines produced can be made as widely available and as inexpensive soon as possible.” 

Dan Sullivan in the American Prospect suggests the U.S. should nationalize all the airlines. Some have gone so far as calling for nationalization of the U.S. oil industry.

On the one hand, it’s clear that de Blasio and Brown have no confidence in the price system to efficiently allocate resources. Alternatively, they may have overconfidence in the political/bureaucratic system to efficiently, and “equitably,” distribute resources. On the other hand, as Daniel Takash points out in an earlier post, both pharmaceuticals and oil are relatively unpopular industries with many Americans, in which case the threat of a government takeover has a big dose of populist score settling:

Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular–trailing behind fossil fuels, lawyers, and even the federal government. 

In the early days of the pandemic, France’s finance minister Bruno Le Maire promised to protect “big French companies.” The minister identified a range of actions under consideration: “That can be done by recapitalization, that can be done by taking a stake, I can even use the term nationalization if necessary.” While he did not mention any specific companies, it’s been speculated Air France KLM may be a target.

The Italian government is expected to nationalize Alitalia soon. The airline has been in state administration since May 2017, and the Italian government will have 100% control of the airline by June. Last week, the German government took a 20% stake in Lufthansa, in what has been characterized as a “temporary partial nationalization.” In Canada, Prime Minister Justin Trudeau has been coy about speculation that the government might nationalize Air Canada. 

Obviously, these takeovers have “bailout” written all over them, and bailouts have their own anticompetitive consequences that can be worse than those associated with mergers. For example, RyanAir announced it will contest the aid package for Lufthansa. RyanAir chief executive Michael O’Leary claims the aid will allow Lufthansa to “engage in below-cost selling” and make it harder for RyanAir and its rival low-cost carrier EasyJet to compete. 

There is also a bit of a “national champion” aspect to the takeovers. Each of the potential targets are (or were) considered their nation’s flagship airline. World Bank economists Tanja Goodwin and Georgiana Pop highlight the risk of nationalization harming competition: 

These [sic] should avoid rescuing firms that were already failing. …  But governments should also refrain from engaging in production or service delivery in industries that can be served by the private sector. The role of SOEs [state owned enterprises] should be assessed in order to ensure that bailout packages are not exclusively and unnecessarily favoring a dominant SOE.

To be sure, COVID-19 related mergers could raise the specter of increased market power post-pandemic. But, this risk must be balanced against the risks posed by a merger moratorium. These include the risk of widespread bankruptcies (that’s another post) and/or the possibility of nationalization of firms and industries. Either option can reduce competition which can bring harm to consumers, employees, and suppliers.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]

Earlier this week, merger talks between Uber and food delivery service Grubhub surfaced. House Antitrust Subcommittee Chairman David N. Cicilline quickly reacted to the news:

Americans are struggling to put food on the table, and locally owned businesses are doing everything possible to keep serving people in our communities, even under great duress. Uber is a notoriously predatory company that has long denied its drivers a living wage. Its attempt to acquire Grubhub—which has a history of exploiting local restaurants through deceptive tactics and extortionate fees—marks a new low in pandemic profiteering. We cannot allow these corporations to monopolize food delivery, especially amid a crisis that is rendering American families and local restaurants more dependent than ever on these very services. This deal underscores the urgency for a merger moratorium, which I and several of my colleagues have been urging our caucus to support.

Pandemic profiteering rolls nicely off the tongue, and we’re sure to see that phrase much more over the next year or so. 

Grubhub shares jumped 29% Tuesday, the day the merger talks came to light, shown in the figure below. The Wall Street Journal reports companies are considering a deal that would value Grubhub stock at around 1.9 Uber shares, or $60-65 dollars a share, based on Thursday’s price.

But is that “pandemic profiteering?”

After Amazon announced its intended acquisition of Whole Foods, the grocer’s stock price soared by 27%. Rep. Cicilline voiced some convoluted concerns about that merger, but said nothing about profiteering at the time. Different times, different messaging.

Rep. Cicilline and others have been calling for a merger moratorium during the pandemic and used the Uber/Grubhub announcement as Exhibit A in his indictment of merger activity.

A moratorium would make things much easier for regulators. No more fighting over relevant markets, no HHI calculations, no experts debating SSNIPs or GUPPIs, no worries over consumer welfare, no failing firm defenses. Just a clear, brightline “NO!”

Even before the pandemic, it was well known that the food delivery industry was due for a shakeout. NPR reports, even as the business is growing, none of the top food-delivery apps are turning a profit, with one analyst concluding consolidation was “inevitable.” Thus, even if a moratorium slowed or stopped the Uber/Grubhub merger, at some point a merger in the industry will happen and the U.S. antitrust authorities will have to evaluate it.

First, we have to ask, “What’s the relevant market?” The government has a history of defining relevant markets so narrowly that just about any merger can be challenged. For example, for the scuttled Whole Foods/Wild Oats merger, the FTC famously narrowed the market to “premium natural and organic supermarkets.” Surely, similar mental gymnastics will be used for any merger involving food delivery services.

While food delivery has grown in popularity over the past few years, delivery represents less than 10% of U.S. food service sales. While Rep. Cicilline may be correct that families and local restaurants are “more dependent than ever” on food delivery, delivery is only a small fraction of a large market. Even a monopoly of food delivery service would not confer market power on the restaurant and food service industry.

No reasonable person would claim an Uber/Grubhub merger would increase market power in the restaurant and food service industry. But, it might convey market power in the food delivery market. Much attention is paid to the “Big Four”–DoorDash, Grubhub, Uber Eats, and Postmates. But, these platform delivery services are part of the larger food service delivery market, of which platforms account for about half of the industry’s revenues. Pizza accounts for the largest share of restaurant-to-consumer delivery.

This raises the big question of what is the relevant market: Is it the entire food delivery sector, or just the platform-to-consumer sector? 

Based on the information in the figure below, defining the market narrowly would place an Uber/Grubhub merger squarely in the “presumed to be likely to enhance market power” category.

  • 2016 HHI: <3,175
  • 2018 HHI: <1,474
  • 2020 HHI: <2,249 pre-merger; <4,153 post-merger

Alternatively, defining the market to encompass all food delivery would cut the platforms’ shares roughly in half and the merger would be unlikely to harm competition, based on HHI. Choosing the relevant market is, well, relevant.

The Second Measure data suggests that concentration in the platform delivery sector decreased with the entry of Uber Eats, but subsequently increased with DoorDash’s rising share–which included the acquisition of Caviar from Square.

(NB: There seems to be a significant mismatch in the delivery revenue data. Statista reports platform delivery revenues increased by about 40% from 2018 to 2020, but Second Measure indicates revenues have more than doubled.) 

Geoffrey Manne, in an earlier post points out “while national concentration does appear to be increasing in some sectors of the economy, it’s not actually so clear that the same is true for local concentration — which is often the relevant antitrust market.” That may be the case here.

The figure below is a sample of platform delivery shares by city. I added data from an earlier study of 2017 shares. In all but two metro areas, Uber and Grubhub’s combined market share declined from 2017 to 2020. In Boston, the combined shares did not change and in Los Angeles, the combined shares increased by 1%.

(NB: There are some serious problems with this data, notably that it leaves out the restaurant-to-consumer sector and assumes the entire platform-to-consumer sector is comprised of only the “Big Four.”)

Platform-to-consumer delivery is a complex two-sided market in which the platforms link, and compete for, both restaurants and consumers. Platforms compete for restaurants, drivers, and consumers. Restaurants have a choice of using multiple platforms or entering into exclusive arrangements. Many drivers work for multiple platforms, and many consumers use multiple platforms. 

Fundamentally, the rise of platform-to-consumer is an evolution in vertical integration. Restaurants can choose to offer no delivery, use their own in-house delivery drivers, or use a third party delivery service. Every platform faces competition from in-house delivery, placing a limit on their ability to raise prices to restaurants and consumers.

The choice of delivery is not an either-or decision. For example, many pizza restaurants who have their own delivery drivers also use platform delivery service. Their own drivers may serve a limited geographic area, but the platforms allow the restaurant to expand its geographic reach, thereby increasing its sales. Even so, the platforms face competition from in-house delivery.

Mergers or other forms of shake out in the food delivery industry are inevitable. Mergers will raise important questions about relevant product and geographic markets as well as competition in two-sided markets. While there is a real risk of harm to restaurants, drivers, and consumers, there is also a real possibility of welfare enhancing efficiencies. These questions will never be addressed with an across-the-board merger moratorium.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Noah Phillips[1] (Commissioner of the U.S. Federal Trade Commission).]   

Never let a crisis go to waste, or so they say. In the past two weeks, some of the same people who sought to stop mergers and acquisitions during the bull market took the opportunity of the COVID-19 pandemic and the new bear market to call to ban M&A. On Friday, April 24th, Rep. David Cicilline proposed that a merger ban be included in the next COVID-19-related congressional legislative package.[2] By Monday, Senator Elizabeth Warren and Rep. Alexandria Ocasio-Cortez, warning of “predatory” M&A and private equity “vultures”, teamed up with a similar proposal.[3] 

I’m all for stopping anticompetitive M&A that we cannot resolve. In the past few months alone, the Federal Trade Commission has been quite busy, suing to stop transactions in the hospital, e-cigarette, coal, body-worn camera, razor, and gene sequencing industries, and forcing deals to stop in the pharmaceutical, medical staffing, and consumer products spaces. But is a blanket ban, unprecedented in our nation’s history, warranted, now? 

The theory that the pandemic requires the government to shut down M&A goes something like this: the antitrust agencies are overwhelmed and cannot do the job of reviewing mergers under the Hart-Scott-Rodino (HSR) Act, which gives the U.S. antitrust agencies advance notice of certain transactions and 30 days to decide whether to seek more information about them.[4] That state of affairs will, in turn, invite a rush of companies looking to merge with minimal oversight, exacerbating the problem by flooding the premerger notification office (PNO) with new filings. Another version holds, along similar lines, that the precipitous decline in the market will precipitate a merger “wave” in which “dominant corporations” and “private equity vultures” will gobble up defenseless small businesses. Net result: anticompetitive transactions go unnoticed and unchallenged. That’s the theory, at least as it has been explained to me. The facts are different.

First, while the restrictions related to COVID-19 require serious adjustments at the antitrust agencies just as they do at workplaces across the country (we’re working from home, dealing with remote technology, and handling kids just like the rest), merger review continues. Since we started teleworking, the FTC has, among other things, challenged Altria’s $12.8 billion investment in JUUL’s e-cigarette business and resolved competitive concerns with GE’s sale of its biopharmaceutical business to Danaher and Ossur’s acquisition of a competing prosthetic limbs manufacturer, College Park. With our colleagues at the Antitrust Division of the Department of Justice, we announced a new e-filing system for HSR filings and temporarily suspended granting early termination. We sought voluntary extensions from companies. But, in less than two weeks, we were able to resume early termination—back to “new normal”, at least. I anticipate there may be additional challenges; and the FTC will assess constraints in real-time to deal with further disruptions. But we have not sacrificed the thoroughness of our investigations; and we will not.

Second, there is no evidence of a merger “wave”, or that the PNO is overwhelmed with HSR filings. To the contrary, according to Bloomberg, monthly M&A volume hit rock bottom in April – the lowest since 2004. As of last week, the PNO estimates nearly 60% reduction in HSR reported transactions during the past month, compared to the historical average. Press reports indicate that M&A activity is down dramatically because of the crisis. Xerox recently announced it was suspending its hostile bid for Hewlett-Packard ($30 billion); private equity firm Sycamore Partners announced it is walking away from its takeover of Victoria’s Secret ($525 million); and Boeing announced it is backing out of its merger with Embraer ($4.2 billion) — just a few examples of companies, large corporations and private equity firms alike, stopping M&A on their own. (The market is funny like that.)

Slowed M&A during a global pandemic and economic crisis is exactly what you would expect. The financial uncertainty facing companies lowers shareholder and board confidence to dive into a new acquisition or sale. Financing is harder to secure. Due diligence is postponed. Management meetings are cancelled. Agreeing on price is another big challenge. The volatility in stock prices makes valuation difficult, and lessens the value of equity used to acquire. Cash is needed elsewhere, like to pay workers and keep operations running. Lack of access to factories and other assets as a result of travel restrictions and stay-at-home orders similarly make valuation harder. Management can’t even get in a room to negotiate and hammer out the deal because of social distancing (driving a hard bargain on Zoom may not be the same).

Experience bears out those expectations. Consider our last bear market, the financial crisis that took place over a decade ago. Publicly available FTC data show the number of HSR reported transactions dropped off a cliff. During fiscal year 2009, the height of the crisis, HSR reported transactions were down nearly 70% compared to just two years earlier, in fiscal year 2007. Not surprising.

Source: https://www.ftc.gov/site-information/open-government/data-sets

Nor should it be surprising that the current crisis, with all its uncertainty and novelty, appears itself to be slowing down M&A.

So, the antitrust agencies are continuing merger review, and adjusting quickly to the new normal. M&A activity is down, dramatically, on its own. That makes the pandemic an odd excuse to stop M&A. Maybe the concern wasn’t really about the pandemic in the first place? The difference in perspective may depend on one’s general view of the value of M&A. If you think mergers are mostly (or all) bad, and you discount the importance of the market for corporate control, the cost to stopping them all is low. If you don’t, the cost is high.[5]

As a general matter, decades of research and experience tell us that the vast majority of mergers are either pro-competitive or competitively-neutral.[6] But M&A, even dramatically-reduced, also has an important role to play in a moment of economic adjustment. It helps allocate assets in an efficient manner, for example giving those with the wherewithal to operate resources (think companies, or plants) an opportunity that others may be unable to utilize. Consumers benefit if a merger leads to the delivery of products or services that one company could not efficiently provide on its own, and from the innovation and lower prices that better management and integration can provide. Workers benefit, too, as they remain employed by going concerns.[7] It serves no good, including for competition, to let companies that might live, die.[8]

M&A is not the only way in which market forces can help. The antitrust agencies have always recognized pro-competitive benefits to collaboration between competitors during times of crisis.  In 2005, after hurricanes Katrina and Rita, we implemented an expedited five-day review of joint projects between competitors aimed at relief and construction. In 2017, after hurricanes Harvey and Irma, we advised that hospitals could combine resources to meet the health care needs of affected communities and companies could combine distribution networks to ensure goods and services were available. Most recently, in response to the current COVID-19 emergency, we announced an expedited review process for joint ventures. Collaboration can be concerning, so we’re reviewing; but it can also help.

Our nation is going through an unprecedented national crisis, with a horrible economic component that is putting tens of millions out of work and causing a great deal of suffering. Now is a time of great uncertainty, tragedy, and loss; but also of continued hope and solidarity. While merger review is not the top-of-mind issue for many—and it shouldn’t be—American consumers stand to gain from pro-competitive mergers, during and after the current crisis. Those benefits would be wiped out with a draconian ‘no mergers’ policy during the COVID-19 emergency. Might there be anticompetitive merger activity? Of course, which is why FTC staff are working hard to vet potentially anticompetitive mergers and prevent harm to consumers. Let’s let them keep doing their jobs.


[1] The views expressed in this blog post are my own and do not necessarily reflect the views of the Federal Trade Commission or any other commissioner. An abbreviated version of this essay was previously published in the New York Times’ DealBook newsletter. Noah Phillips, The case against banning mergers, N.Y. Times, Apr. 27, 2020, available at https://www.nytimes.com/2020/04/27/business/dealbook/small-business-ppp-loans.html.

[2] The proposal would allow transactions only if a company is already in bankruptcy or is otherwise about to fail.

[3] The “Pandemic Anti-Monopoly Act” proposes a merger moratorium on (1) firms with over $100 million in revenue or market capitalization of over $100 million; (2) PE firms and hedge funds (or entities that are majority-owned by them); (3) businesses that have an exclusive patent on products related to the crisis, such as personal protective equipment; and (4) all HSR reportable transactions.

[4] Hart-Scott-Rodino Antitrust Improvements Act of 1976, 15 U.S.C. § 18a. The antitrust agencies can challenge transactions after they happen, but they are easier to stop beforehand; and Congress designed HSR to give us an opportunity to do so.

[5] Whatever your view, the point is that the COVID-19 crisis doesn’t make sense as a justification for banning M&A. If ban proponents oppose M&A generally, they should come out and say that. And they should level with the public about just how much they propose to ban. The specifics of the proposals are beyond the scope of this essay, but it’s worth noting that the “large companies [gobbling] up . . . small businesses” of which Sen. Warren warns include any firm with $100 million in annual revenue and anyone making a transaction reportable under HSR. $100 million seems like a lot of money to many of us, but the Ohio State University National Center for the Middle Market defines a mid-sized company as having annual revenues between $10 million and $1 billion. Many if not most of the transactions that would be banned look nothing like the kind of acquisitions ban proponents are describing.

[6] As far back as the 1980s, the Horizontal Merger Guidelines reflected this idea, stating: “While challenging competitively harmful mergers, the Department [of Justice Antitrust Division] seeks to avoid unnecessary interference with the larger universe of mergers that are either competitively beneficial or neutral.” Horizontal Merger Guidelines (1982); see also Hovenkamp, Appraising Merger Efficiencies, 24 Geo. Mason L. Rev. 703, 704 (2017) (“we tolerate most mergers because of a background, highly generalized belief that most—or at least many—do produce cost savings or improvements in products, services, or distribution”); Andrade, Mitchell & Stafford, New Evidence and Perspectives on Mergers, 15 J. ECON. PERSPECTIVES 103, 117 (2001) (“We are inclined to defend the traditional view that mergers improve efficiency and that the gains to shareholders at merger announcement accurately reflect improved expectations of future cash flow performance.”).

[7] Jointly with our colleagues at the Antitrust Division of the Department of Justice, we issued a statement last week affirming our commitment to enforcing the antitrust laws against those who seek to exploit the pandemic to engage in anticompetitive conduct in labor markets.

[8] The legal test to make such a showing for an anti-competitive transaction is high. Known as the “failing firm defense”, it is available only to firms that can demonstrate their fundamental inability to compete effectively in the future. The Horizontal Merger Guidelines set forth three elements to establish the defense: (1) the allegedly failing firm would be unable to meet its financial obligations in the near future; (2) it would not be able to reorganize successfully under Chapter 11; and (3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than the actual merger. Horizontal Merger Guidelines § 11; see also Citizen Publ’g v. United States, 394 U.S. 131, 137-38 (1969). The proponent of the failing firm defense bears the burden to prove each element, and failure to prove a single element is fatal. In re Otto Bock, FTC No. 171-0231, Docket No. 9378 Commission Opinion (Nov. 2019) at 43; see also Citizen Publ’g, 394 U.S. at 138-39.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Steve Cernak, (Partner, Bona Law).]

The antitrust laws have not been suspended during the current COVID-19 crisis. But based on questions received from clients plus others discussed with other practitioners, the changed economic conditions have raised some new questions and put a new slant on some old ones. 

Under antitrust law’s flexible rule of reason standard, courts and enforcers consider the competitive effect of most actions under current and expected economic conditions. Because those conditions have changed drastically, at least temporarily, perhaps the antitrust assessments of certain actions will be different. Also, in a crisis, good businesses consider new options and reconsider others that had been rejected under the old conditions. So antitrust practitioners and enforcers need to be prepared for new questions and reconsiderations of others under new facts. Here are some that might cross their desks.

Benchmarking

Benchmarking had its antitrust moment a few years ago as practitioners discovered and began to worry about this form of communication with competitors. Both before and since then, the comparison of processes and metrics to industry bests to determine where improvement efforts should be concentrated has not raised serious antitrust issues – if done properly. Appropriate topic choice and implementation, often involving counsel review and third-party collection, should stay the same during this crisis. Companies implementing new processes might be tempted to reach out to competitors to learn best practices. Any of those companies unfamiliar with the right way to benchmark should get up to speed. Counsel must be prepared to help clients quickly, but properly, benchmark some suddenly important activities, like methods for deep-cleaning workplaces.

Joint ventures

Joint ventures where competitors work together to accomplish a task that neither could alone, or accomplish it more efficiently, have always received a receptive antitrust review. Often, those joint efforts have been temporary. Properly structured ones have always required the companies to remain competitors outside the joint venture. Joint efforts among competitors that did not make sense before the crisis might make perfect sense during it. For instance, a company whose distribution warehouse has been shut down by a shelter in place order might be able to use a competitor’s distribution assets to continue to get goods to the market. 

Some joint ventures of competitors have received special antitrust assurances for decades. The National Cooperative Research and Production Act of 1993 was originally passed in 1984 to protect research joint ventures of competitors. It was later extended to certain joint production efforts and standard development organizations. The law confirms that certain joint ventures of competitors will be judged under the rule of reason. If the parties file a very short notice with the DOJ Antitrust Division and FTC, they also will receive favorable treatment regarding damages and attorney’s fees in any antitrust lawsuit. For example, competitors cooperating on the development of new virus treatments might be able to use NCRPA to protect joint research and even production of the cure. 

Mergers

Horizontal mergers that permanently combine the assets of two competitors are unlikely to be justified under the antitrust laws by small transitory blips in the economic landscape. A huge crisis, however, might be so large and create such long-lasting effects that certain mergers suddenly might make sense, both on business and antitrust grounds. That rationale was used during the most recent economic crisis to justify several large mergers of banks although other large industrial mergers considered at the same time were abandoned for various reasons. It is not yet clear if that reasoning is present in any industry now. 

Remote communication among competitors

On a much smaller but more immediate scale, the new forms of communication being used while so many of us are physically separated have raised questions about the usual antitrust advice regarding communication with competitors. Antitrust practitioners have long advised clients about how to prepare and conduct an in-person meeting of competitors, say at a trade association convention. That same advice would seem to apply if, with the in-person convention cancelled, the meeting will be held via Teams or Zoom. And don’t forget: The reminders that the same rules apply to the cocktail party at the bar after the meeting should also be given for the virtual version conducted via Remo.co

Pricing and brand Management

Since at least the time when the Dr. Miles Medical Co. was selling its “restorative nervine,” manufacturers have been concerned about how their products were resold by retailers. Antitrust law has provided manufacturers considerable freedom for some time to impose non-price restraints on retailers to protect brand reputations; however, manufacturers must consider and impose those restraints before a crisis hits. For instance, a “no sale for resale” provision in place before the crisis would give a manufacturer of hand sanitizer another tool to use now to try to prevent bulk sales of the product that will be immediately resold on the street. 

Federal antitrust law has provided manufacturers considerable freedom to impose maximum price restraints. Even the states whose laws prevent minimum price restraints do not seem as concerned about maximum ones. But again, if a manufacturer is concerned that some consumer will blame it, not just the retailer, for a sudden skyrocketing price for a product in short supply, some sort of restraints must be in place before the crisis. Certain platforms are invoking their standard policies to prevent such actions by resellers on their platforms. 

Regulatory hurdles

While antitrust law is focused on actions by private parties that might prevent markets from properly working to serve consumers, the same rationales apply to unnecessary government interference in the market. The current health crisis has turned the spotlight back on certificate of need laws, a form of “brother may I?” government regulation that can allow current competitors to stifle entry by new competitors. Similarly, regulations that have slowed the use of telemedicine have been at least temporarily waived

Conclusion

Solving the current health crisis and rebuilding the economy will take the best efforts of both our public institutions and private companies. Antitrust law as currently written and enforced can and should continue to play a role in aligning incentives so we need not rely on “the benevolence of the butcher” for our dinner and other necessities. Instead, proper application of antitrust law can allow companies to do their part to (reviving a slogan helpful in a prior national crisis) keep America rolling.

In antitrust lore, mavericks are magical creatures that bring order to a world on the verge of monopoly. Because they are so hard to find in the wild, some researchers have attempted to create them in the laboratory. While the alchemists couldn’t turn lead into gold, they did discover zinc. Similarly, although modern day researchers can’t turn students into mavericks, they have created a useful classroom exercise.

In a Cambridge University working paper, Donja Darai, Catherine Roux, and Frédéric Schneider develop a simple experiment to model merger activity in the face of price competition. Based on their observations they conclude (1) firms are more likely to make merger offers when prices are closer to marginal cost and (2) “maverick firms” – firms who charge a lower price – are more likely to be on the receiving end of those merger offers. Based on these conclusions, they suggest “mergers may be used to eliminate mavericks from the market and thus substitute for failed attempts at collusion between firms.”

The experiment is a set of games broken up into “market” phases and “merger” phases.

  • Each experiment has four subjects, with each subject representing a firm.
  • Each firm has marginal cost of zero and no capacity constraints.
  • Each experiment has nine phases: five “market” phases of 10 trading periods and a four “merger” phases.
  • During a trading period, firms simultaneously post their asking prices, ranging from 0 to 100 “currency units.” Subjects cannot communicate their prices to each other.
  • A computerized “buyer” purchases 300 units of the good at the lowest posted price. In the case of identical lowest prices, the sales are split equally among the firms with the lowest posted price.
  • At the end of the market phase, the firms enter a merger phase in which any firm can offer to merge with any other firm. Firms being made an offer to merge can accept or reject the offer. There are no price terms for the merger. Instead, the subject controlling the acquired firm receives an equal share of the acquiring firm’s profits in subsequent trading periods. Each firm can acquire only one other firm in each merger round.
  • The market-merger phases repeat, ending with a final market phase.
  • Subjects receive cash compensation related to the the “profits” their firm earned over the course of the experiment.

Merger to monopoly is a dominant strategy: It is the clearest path to maximizing individual and joint profits. In that way it’s a pretty boring game. Bid low, merge toward monopoly, then bid 100 every turn after that. The only real “trick” is convincing the other players to merge.

The authors attempt to make the paper more interesting by introducing the idea of the “maverick” bidder who bids low. They find that the lowest bidders are more likely to receive merger offers than the other subjects. They also find that these so-called mavericks are more reluctant to accept a merger offer. 

I noted in my earlier post that modeling the “maverick” seems to be a fool’s errand. If firms are assumed to face the same cost and demand conditions, why would any single firm play the role of the maverick? In the standard prisoner’s dilemma problem, every firm has the incentive to be the maverick. If everyone’s a maverick, then no one’s a maverick. On the other hand, if one firm has unique cost or demand conditions or is assumed to have some preference for “mavericky” behavior, then the maverick model is just an ad hoc model where the conclusions are baked into the assumptions.

Darai, et al.’s experiment suffers from these same criticisms. They define the “maverick” as a low bidder who does not accept merger offers. But, they don’t have a model for why they behave the way they do. Some observations:

  • Another name for “low bidder” is “winner.” If the low bidders consistently win in the market phase, then they may believe that they have some special skill or luck that the other subjects don’t have. Why would a winner accept a merger bid from – and share his or her profits with – one or more “losers.”  
  • Another name for “low bidder” could be “newbie.” The low bidder may be the subject who doesn’t understand that the dominant strategy is to merge to monopoly as fast as possible and charge the maximum price. The other players conclude the low bidder doesn’t know how to play the game. In other words, the merger might be viewed more as a hostile takeover to replace “bad” management. Because even bad managers won’t admit they’re bad, they make another bad decision and resist the merger.
  • About 80% of the time, the experiment ends with a monopoly, indicating that even the mavericks eventually merge. 

See what I just did? I created my own ad hoc theories of the maverick. In one theory, the maverick thinks he or she has some unique ability to pick the winning asking price. In the other, the maverick is making decisions counter to its own – and other players’ – long term self-interest. 

Darai, et al. have created a fun game. I played a truncated version of it with my undergraduate class earlier this week and it generated a good discussion about pricing and coordination. But, please don’t call it a model of the maverick.

On Monday evening, around 6:00 PM Eastern Standard Time, news leaked that the United States District Court for the Southern District of New York had decided to allow the T-Mobile/Sprint merger to go through, giving the companies a victory over a group of state attorneys general trying to block the deal.

Thomas Philippon, a professor of finance at NYU, used this opportunity to conduct a quick-and-dirty event study on Twitter:

Short thread on T-Mobile/Sprint merger. There were 2 theories:

(A) It’s a 4-to-3 merger that will lower competition and increase markups.

(B) The new merged entity will be able to take on the industry leaders AT&T and Verizon.

(A) and (B) make clear predictions. (A) predicts the merger is good news for AT&T and Verizon’s shareholders. (B) predicts the merger is bad news for AT&T and Verizon’s shareholders. The news leaked at 6pm that the judge would approve the merger. Sprint went up 60% as expected. Let’s test the theories. 

Here is Verizon’s after trading price: Up 2.5%.

Here is ATT after hours: Up 2%.

Conclusion 1: Theory B is bogus, and the merger is a transfer of at least 2%*$280B (AT&T) + 2.5%*$240B (Verizon) = $11.6 billion from the pockets of consumers to the pockets of shareholders. 

Conclusion 2: I and others have argued for a long time that theory B was bogus; this was anticipated. But lobbying is very effective indeed… 

Conclusion 3: US consumers already pay two or three times more than those of other rich countries for their cell phone plans. The gap will only increase.

And just a reminder: these firms invest 0% of the excess profits. 

Philippon published his thread about 40 minutes prior to markets opening for regular trading on Tuesday morning. The Court’s official decision was published shortly before markets opened as well. By the time regular trading began at 9:30 AM, Verizon had completely reversed its overnight increase and opened down from the previous day’s close. While AT&T opened up slightly, it too had given back most of its initial gains. By 11:00 AM, AT&T was also in the red. When markets closed at 4:00 PM on Tuesday, Verizon was down more than 2.5 percent and AT&T was down just under 0.5 percent.

Does this mean that, in fact, theory A is the “bogus” one? Was the T-Mobile/Sprint merger decision actually a transfer of “$7.4 billion from the pockets of shareholders to the pockets of consumers,” as I suggested in my own tongue-in-cheek thread later that day? In this post, I will look at the factors that go into conducting a proper event study.  

What’s the appropriate window for a merger event study?

In a response to my thread, Philippon said, “I would argue that an event study is best done at the time of the event, not 16 hours after. Leak of merger approval 6 pm Monday. AT&T up 2 percent immediately. AT&T still up at open Tuesday. Then comes down at 10am.” I don’t disagree that “an event study is best done at the time of the event.” In this case, however, we need to consider two important details: When was the “event” exactly, and what were the conditions in the financial markets at that time?

This event did not begin and end with the leak on Monday night. The official announcement came Tuesday morning when the full text of the decision was published. This additional information answered a few questions for market participants: 

  • Were the initial news reports true?
  • Based on the text of the decision, what is the likelihood it gets reversed on appeal?
    • Wall Street: “Not all analysts are convinced this story is over just yet. In a note released immediately after the judge’s verdict, Nomura analyst Jeff Kvaal warned that ‘we expect the state AGs to appeal.’ RBC Capital analyst Jonathan Atkin noted that such an appeal, if filed, could delay closing of the merger by ‘an additional 4-5’ months — potentially delaying closure until September 2020.”
  • Did the Court impose any further remedies or conditions on the merger?

As stock traders digested all the information from the decision, Verizon and AT&T quickly went negative. There is much debate in the academic literature about the appropriate window for event studies on mergers. But the range in question is always one of days or weeks — not a couple hours in after hours markets. A recent paper using the event study methodology analyzed roughly 5,000 mergers and found abnormal returns of about positive one percent for competitors in the relevant market following a merger announcement. Notably for our purposes, this small abnormal return builds in the first few days following a merger announcement and persists for up to 30 days, as shown in the chart below:

As with the other studies the paper cites in its literature review, this particular research design included a window of multiple weeks both before and after the event occured. When analyzing the T-Mobile/Sprint merger decision, we should similarly expand the window beyond just a few hours of after hours trading.

How liquid is the after hours market?

More important than the length of the window, however, is the relative liquidity of the market during that time. The after hours market is much thinner than the regular hours market and may not reflect all available information. For some rough numbers, let’s look at data from NASDAQ. For the last five after hours trading sessions, total volume was between 80 and 100 million shares. Let’s call it 90 million on average. By contrast, the total volume for the last five regular trading hours sessions was between 2 and 2.5 billion shares. Let’s call it 2.25 billion on average. So, the regular trading hours have roughly 25 times as much liquidity as the after hours market

We could also look at relative liquidity for a single company as opposed to the total market. On Wednesday during regular hours (data is only available for the most recent day), 22.49 million shares of Verizon stock were traded. In after hours trading that same day, fewer than a million shares traded hands. You could change some assumptions and account for other differences in the after market and the regular market when analyzing the data above. But the conclusion remains the same: the regular market is at least an order of magnitude more liquid than the after hours market. This is incredibly important to keep in mind as we compare the after hours price changes (as reported by Philippon) to the price changes during regular trading hours.

What are Wall Street analysts saying about the decision?

To understand the fundamentals behind these stock moves, it’s useful to see what Wall Street analysts are saying about the merger decision. Prior to the ruling, analysts were already worried about Verizon’s ability to compete with the combined T-Mobile/Sprint entity in the short- and medium-term:

Last week analysts at LightShed Partners wrote that if Verizon wins most of the first available tranche of C-band spectrum, it could deploy 60 MHz in 2022 and see capacity and speed benefits starting in 2023.

With that timeline, C-Band still does not answer the questions of what spectrum Verizon will be using for the next three years,” wrote LightShed’s Walter Piecyk and Joe Galone at the time.

Following the news of the decision, analysts were clear in delivering their own verdict on how the decision would affect Verizon:

Verizon looks to us to be a net loser here,” wrote the MoffettNathanson team led by Craig Moffett.

…  

Approval of the T-Mobile/Sprint deal takes not just one but two spectrum options off the table,” wrote Moffett. “Sprint is now not a seller of 2.5 GHz spectrum, and Dish is not a seller of AWS-4. More than ever, Verizon must now bet on C-band.”

LightShed also pegged Tuesday’s merger ruling as a negative for Verizon.

“It’s not great news for Verizon, given that it removes Sprint and Dish’s spectrum as an alternative, created a new competitor in Dish, and has empowered T-Mobile with the tools to deliver a superior network experience to consumers,” wrote LightShed.

In a note following news reports that the court would side with T-Mobile and Sprint, New Street analyst Johnathan Chaplin wrote, “T-Mobile will be far more disruptive once they have access to Sprint’s spectrum than they have been until now.”

However, analysts were more sanguine about AT&T’s prospects:

AT&T, though, has been busy deploying additional spectrum, both as part of its FirstNet build and to support 5G rollouts. This has seen AT&T increase its amount of deployed spectrum by almost 60%, according to Moffett, which takes “some of the pressure off to respond to New T-Mobile.”

Still, while AT&T may be in a better position on the spectrum front compared to Verizon, it faces the “same competitive dynamics,” Moffett wrote. “For AT&T, the deal is probably a net neutral.”

The quantitative evidence from the stock market seems to agree with the qualitative analysis from the Wall Street research firms. Let’s look at the five-day window of trading from Monday morning to Friday (today). Unsurprisingly, Sprint, T-Mobile, and Dish have reacted very favorably to the news:

Consistent with the Wall Street analysis, Verizon stock remains down 2.5 percent over a five-day window while AT&T has been flat over the same period:

How do you separate beta from alpha in an event study?

Philippon argued that after market trading may be more efficient because it is dominated by hedge funds and includes less “noise trading.” In my opinion, the liquidity effect likely outweighs this factor. Also, it’s unclear why we should assume “smart money” is setting the price in the after hours market but not during regular trading when hedge funds are still active. Sophisticated professional traders often make easy profits by picking off panicked retail investors who only read the headlines. When you see a wild swing in the markets that moderates over time, the wild swing is probably the noise and the moderation is probably the signal.

And, as Karl Smith noted, since the aftermarket is thin, price moves in individual stocks might reflect changes in the broader stock market (“beta”) more than changes due to new company-specific information (“alpha”). Here are the last five days for e-mini S&P 500 futures, which track the broader market and are traded after hours:

The market trended up on Monday night and was flat on Tuesday. This slightly positive macro environment means we would need to adjust the returns downward for AT&T and Verizon. Of course, this is counter to Philippon’s conjecture that the merger decision would increase their stock prices. But to be clear, these changes are so minuscule in percentage terms, this adjustment wouldn’t make much of a difference in this case.

Lastly, let’s see what we can learn from a similar historical episode in the stock market.

The parallel to the 2016 presidential election

The type of reversal we saw in AT&T and Verizon is not unprecedented. Some commenters said the pattern reminded them of the market reaction to Trump’s election in 2016:

Much like the T-Mobile/Sprint merger news, the “event” in 2016 was not a single moment in time. It began around 9 PM Tuesday night when Trump started to overperform in early state results. Over the course of the next three hours, S&P 500 futures contracts fell about 5 percent — an enormous drop in such a short period of time. If Philippon had tried to estimate the “Trump effect” in the same manner he did the T-Mobile/Sprint case, he would have concluded that a Trump presidency would reduce aggregate future profits by about 5 percent relative to a Clinton presidency.

But, as you can see in the chart above, if we widen the aperture of the event study to include the hours past midnight, the story flips. Markets started to bounce back even before Trump took the stage to make his victory speech. The themes of his speech were widely regarded as reassuring for markets, which further pared losses from earlier in the night. When regular trading hours resumed on Wednesday, the markets decided a Trump presidency would be very good for certain sectors of the economy, particularly finance, energy, biotech, and private prisons. By the end of the day, the stock market finished up about a percentage point from where it closed prior to the election — near all time highs.

Maybe this is more noise than signal?

As a few others pointed out, these relatively small moves in AT&T and Verizon (less than 3 percent in either direction) may just be noise. That’s certainly possible given the magnitude of the changes. Contra Philippon, I think the methodology in question is too weak to rule out the pro-competitive theory of the case, i.e., that the new merged entity would be a stronger competitor to take on industry leaders AT&T and Verizon. We need much more robust and varied evidence before we can call anything “bogus.” Of course, that means this event study is not sufficient to prove the pro-competitive theory of the case, either.

Olivier Blanchard, a former chief economist of the IMF, shared Philippon’s thread on Twitter and added this comment above: “The beauty of the argument. Simple hypothesis, simple test, clear conclusion.”

If only things were so simple.

Jonathan B. Baker, Nancy L. Rose, Steven C. Salop, and Fiona Scott Morton don’t like vertical mergers:

Vertical mergers can harm competition, for example, through input foreclosure or customer foreclosure, or by the creation of two-level entry barriers.  … Competitive harms from foreclosure can occur from the merged firm exercising its increased bargaining leverage to raise rivals’ costs or reduce rivals’ access to the market. Vertical mergers also can facilitate coordination by eliminating a disruptive or “maverick” competitor at one vertical level, or through information exchange. Vertical mergers also can eliminate potential competition between the merging parties. Regulated firms can use vertical integration to evade rate regulation. These competitive harms normally occur when at least one of the markets has an oligopoly structure. They can lead to higher prices, lower output, quality reductions, and reduced investment and innovation.

Baker et al. go so far as to argue that any vertical merger in which the downstream firm is subject to price regulation should face a presumption that the merger is anticompetitive.

George Stigler’s well-known article on vertical integration identifies several ways in which vertical integration increases welfare by subverting price controls:

The most important of these other forces, I believe, is the failure of the price system (because of monopoly or public regulation) to clear markets at prices within the limits of the marginal cost of the product (to the buyer if he makes it) and its marginal-value product (to the seller if he further fabricates it). This phenomenon was strikingly illustrated by the spate of vertical mergers in the United States during and immediately after World War II, to circumvent public and private price control and allocations. A regulated price of OA was set (Fig. 2), at which an output of OM was produced. This quantity had a marginal value of OB to buyers, who were rationed on a nonprice basis. The gain to buyers  and sellers combined from a free price of NS was the shaded area, RST, and vertical integration was the simple way of obtaining this gain. This was the rationale of the integration of radio manufacturers into cabinet manufacture, of steel firms into fabricated products, etc.

Stigler was on to something:

  • In 1947, Emerson Radio acquired Plastimold, a maker of plastic radio cabinets. The president of Emerson at the time, Benjamin Abrams, stated “Plastimold is an outstanding producer of molded radio cabinets and gives Emerson an assured source of supply of one of the principal components in the production of radio sets.” [emphasis added] 
  • In the same year, the Congressional Record reported, “Admiral Corp. like other large radio manufacturers has reached out to take over a manufacturer of radio cabinets, the Chicago Cabinet Corp.” 
  • In 1948, the Federal Trade Commission ascribed wartime price controls and shortages as reasons for vertical mergers in the textiles industry as well as distillers’ acquisitions of wineries.

While there may have been some public policy rationale for price controls, it’s clear the controls resulted in shortages and a deadweight loss in many markets. As such, it’s likely that vertical integration to avoid the price controls improved consumer welfare (if only slightly, as in the figure above) and reduced the deadweight loss.

Rather than leading to monopolization, Stigler provides examples in which vertical integration was employed to circumvent monopolization by cartel quotas and/or price-fixing: “Almost every raw-material cartel has had trouble with customers who wish to integrate backward, in order to negate the cartel prices.”

In contrast to Stigler’s analysis, Salop and Daniel P. Culley begin from an implied assumption that where price regulation occurs, the controls are good for society. Thus, they argue avoidance of the price controls are harmful or against the public interest:

Example: The classic example is the pre-divestiture behavior of AT&T, which allegedly used its purchases of equipment at inflated prices from its wholly-owned subsidiary, Western Electric, to artificially increase its costs and so justify higher regulated prices.

This claim is supported by the court in U.S. v. AT&T [emphasis added]:

The Operating Companies have taken these actions, it is said, because the existence of rate of return regulation removed from them the burden of such additional expense, for the extra cost could simply be absorbed into the rate base or expenses, allowing extra profits from the higher prices to flow upstream to Western rather than to its non-Bell competition.

Even so, the pass-through of higher costs seems only a minor concern to the court relative to the “three hats” worn by AT&T and its subsidiaries in the (1) setting of standards, (2) counseling of operating companies in their equipment purchases, and (3) production of equipment for sale to the operating companies [emphasis added]:

The government’s evidence has depicted defendants as sole arbiters of what equipment is suitable for use in the Bell System a role that carries with it a power of subjective judgment that can be and has been used to advance the sale of Western Electric’s products at the expense of the general trade. First, AT&T, in conjunction with Bell Labs and Western Electric, sets the technical standards under which the telephone network operates and the compatibility specifications which equipment must meet. Second, Western Electric and Bell Labs … serve as counselors to the Operating Companies in their procurement decisions, ostensibly helping them to purchase equipment that meets network standards. Third, Western also produces equipment for sale to the Operating Companies in competition with general trade manufacturers.

The upshot of this “wearing of three hats” is, according to the government’s evidence, a rather obviously anticompetitive situation. By setting technical or compatibility standards and by either not communicating these standards to the general trade or changing them in mid-stream, AT&T has the capacity to remove, and has in fact removed, general trade products from serious consideration by the Operating Companies on “network integrity” grounds. By either refusing to evaluate general trade products for the Operating Companies or producing biased or speculative evaluations, AT&T has been able to influence the Operating Companies, which lack independent means to evaluate general trade products, to buy Western. And the in-house production and sale of Western equipment provides AT&T with a powerful incentive to exercise its “approval” power to discriminate against Western’s competitors.

It’s important to keep in mind that rate of return regulation was not thrust upon AT&T, it was a quid pro quo in which state and federal regulators acted to eliminate AT&T/Bell competitors in exchange for price regulation. In a floor speech to Congress in 1921, Rep. William J. Graham declared:

It is believed to be better policy to have one telephone system in a community that serves all the people, even though it may be at an advanced rate, property regulated by State boards or commissions, than it is to have two competing telephone systems.

For purposes of Salop and Culley’s integration-to-evade-price-regulation example, it’s important to keep in mind that AT&T acquired Western Electric in 1882, or about two decades before telephone pricing regulation was contemplated and eight years before the Sherman Antitrust Act. While AT&T may have used vertical integration to take advantage of rate-of-return price regulation, it’s simply not true that AT&T acquired Western Electric to evade price controls.

Salop and Culley provide a more recent example:

Example: Potential evasion of regulation concerns were raised in the FTC’s analysis in 2008 of the Fresenius/Daiichi Sankyo exclusive sub-license for a Daiichi Sankyo pharmaceutical used in Fresenius’ dialysis clinics, which potentially could allow evasion of Medicare pricing regulations.

As with the AT&T example, this example is not about evasion of price controls. Rather it raises concerns about taking advantage of Medicare’s pricing formula. 

At the time of the deal, Medicare reimbursed dialysis clinics based on a drug manufacturer’s Average Sales Price (“ASP”) plus six percent, where ASP was calculated by averaging the prices paid by all customers, including any discounts or rebates. 

The FTC argued by setting an artificially high transfer price of the drug to Fresenius, the ASP would increase, thereby increasing the Medicare reimbursement to all clinics providing the same drug (which not only would increase the costs to Medicare but also would increase income to all clinics providing the drug). Although the FTC claims this would be anticompetitive, the agency does not describe in what ways competition would be harmed.

The FTC introduces an interesting wrinkle in noting that a few years after the deal would have been completed, “substantial changes to the Medicare program relating to dialysis services … would eliminate the regulations that give rise to the concerns created by the proposed transaction.” Specifically, payment for dialysis services would shift from fee-for-service to capitation.

This wrinkle highlights a serious problem with a presumption that any purported evasion of price controls is an antitrust violation. Namely, if the controls go away, so does the antitrust violation. 

Conversely–as Salop and Culley seem to argue with their AT&T example–a vertical merger could be retroactively declared anticompetitive if price controls are imposed after the merger is completed (even decades later and even if the price regulations were never anticipated at the time of the merger). 

It’s one thing to argue that avoiding price regulation runs counter to public interest, but it’s another thing to argue that avoiding price regulation is anticompetitive. Indeed, as Stigler argues, if the price controls stifle competition, then avoidance of the controls may enhance competition. Placing such mergers under heightened scrutiny, such as an anticompetitive presumption, is a solution in search of a problem.