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On Efficiency, Concentration and Welfare
Abstract
The welfare impact of a merger involves the market power offense and the efficiency defense. Salant et al. (1983) show that mergers among symmetric firms are unprofitable except for monopolization. We characterize the limit to this merger paradox in a simple linear Cournot oligopoly with asymmetric costs. Farrell and Shapiro (1990) provide sufficient conditions for a profitable merger to increase welfare but leave open whether it exists. We characterize the degree of cost asymmetry making a merger both profitable and socially desirable. Comparing rationalization and synergy within the efficiency defense, we show that for most industry structures, a rationalization merger is more likely to be welfare enhancing but a synergy merger is more likely to be profitable.
Industrial Organization, a Contract Based approach (aka IOCB) offers an extensive and an up-to-date panorama of Industrial Organization. It is aimed at advanced undergraduates, graduates, academics and practitioners with an interest in the field. The analysis of market interactions, business strategies and public policy is performed using the standard framework of game theory and the recent advances of contract theory and information economics
This paper extends Farrell and Shapiro (1990) and Levin (1990) by providing necessary and sufficient conditions for horizontal mergers to be both profitable and welfare-enhancing when market demand and firms¡¯ costs are linear. We show that profitable, welfare-enhancing mergers are likely to involve firms whose combined pre-merger market shares exceed 50%, and that mergers may be profitable and welfare-enhancing even when they do not generate any direct cost efficiencies. Our results suggest that any approach to evaluating the welfare effects of horizontal mergers which does not account for industry-wide strategic effects is seriously flawed.
The consequences of a horizontal merger are typically studied by treating the merger as an exogenous change in market structure
that displaces the initial Cournot equilibrium. In the new equilibrium the merged firm is assumed to behave like a multiplant
Cournot player engaged in a noncooperative game against other sellers. The purpose of this article is to evaluate an unnoticed
comparative-static implication of this approach: some exogenous mergers may reduce the endogenous joint profits of the firms
that are assumed to collude. Cournot's original example is used to illustrate this and other bizarre results that can occur
in the Cournot framework if the market structure is treated as exogenous.
We address the question of whether competitive acquisition of firms by their rivals can result in complete or partial monopolization
of a homogeneous product industry. This question is modeled in terms of two distinct three-stage noncoopera-tive games. Analysis
of subgame perfect pure strategy Nash equilibria of these games discloses that, under simplifying assumptions, monopolization
of an industry through acquisition is limited to industries with relatively few firms. Partial monopolization is either limited
in scope or can be completely eliminated by prohibiting any owner from acquiring over 50 percent of the firms in the industry.
To what extent will an industry in which mergers are feasible tend toward monopoly? We analyze this question using a dynamic dominant-firm model with rational agents, endogenous mergers, and constant returns to scale production. We find that long-run industry concentration depends upon the initial concentration. A monopolistic industry will remain monopolized and a perfectly competitive industry will remain perfectly competitive. For intermediate concentration levels, the dominant firm may acquire or sell capital, depending on its ability to commit to future behavior. Industry evolution also depends on the elasticities of demand and supply and the discount factor.
I examine mergers and acquisitions in the U.S. paper and paperboard industry, which experienced a wave of horizontal mergers during the mid-1980s. I describe how the mergers affected investment decisions, costs, and consumers, finding that merged firms lose market share and are more likely to scrap capacity subsequent to an acquisition. I estimate a cost function for individual firms based on an investment model, finding that the efficiency of the majority of acquiring firms increases following an acquisition. Using the estimated cost function, I quantify welfare effects and find evidence of total welfare increases in some paper product categories as a result of the mergers. Copyright 2003 by the RAND Corporation.
The authors analyze horizontal mergers in Cournot oligopoly. They find general conditions under which such mergers raise price, and show that any merger not creating synergies raises price. The authors develop a procedure for analyzing the effect of a merger on rivals and consumers and, thus, provide sufficient conditions for profitable mergers to raise welfare. They show that traditional merger analysis can be misleading in its use of the Herfindahl Index. Their analysis stresses the output responses of large firms not participating in the merger. Copyright 1990 by American Economic Association.
We briefly review the rationale behind technological alliances and provide a snapshot of their role in global competition, especially insofar as it is based around intellectual capital. They nicely illustrate the increased importance of horizontal agreements and thus establish the relevance of the topic. We move on to discuss the organisation of industries in a dynamic context and draw out consequences for competition policy. We conclude with an outlook on the underlying tensions between technology alliances, competition policy, and industrial policy.
Oligopoly models where prior actions by firms affect subsequent marginal costs have been useful in illuminating policy debates in areas such as antitrust regulation, environmental protection, and international competition. The authors discuss properties of such models when a Cournot equilibrium occurs at the second stage. Aggregate production costs strictly decline with no change in gross revenue or gross consumer surplus if the prior actions strictly increase the variance of marginal costs without changing the marginal-cost sum. Therefore, unless the cost of inducing second-stage asymmetry more than offsets this reduction in production costs, the private and social optima are asymmetric.
Passage of the Sherman Act in the United States in 1890 set the stage for a century of jurisprudence regarding monopoly, cartels, and oligopoly. Among American statutes that regulate commerce, the Sherman Act is unequaled in its generality. The Act outlawed "every contract, combination or conspiracy in restraint of trade" and "monopolization" and treated violations as crimes. By these open-ended commands, Congress gave federal judges extraordinary power to draw lines between acceptable cooperation and illegal collusion, between vigorous competition and unlawful monopolization.
As a presidential candidate, Barack Obama was critical of the Bush administration's weak enforcement of antitrust laws. So now the Obama administration has released new horizontal merger guidelines. How do they differ from the old guidelines? And what impact will they have?. © 2011 Wiley Periodicals, Inc.
Recently there has been a notable increase in interest in antitrust law in much of the world. This chapter discusses antitrust policy toward horizontal mergers, the area of antitrust that has seen some of the most dramatic improvements in both economic tools and the application of economics in enforcement practice. The chapter discusses theoretical considerations, merger laws and enforcement practices, econometric methods for analyzing prospective horizontal mergers, and evidence concerning the ex post effects of actual horizontal mergers.
Suppose that a merger (or other combination) is proposed that yields economies but at the same time increases market power. Can the courts and antitrust agencies safely rely, in these circumstances, on a literal reading of the law which prohibits mergers ‘where in any line of commerce or any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly’,1 or does this run the risk of serious economic loss? In the usual merger where both effects are insubstantial this problem is absent.2 But in the occasional case where efficiency and market power consequences exist, can economies be dismissed on the grounds that market power effects invariably dominate ? If they cannot, then a rational treatment of the merger question requires that an effort be made to establish the allocative implications of the scale economy and market power effects associated with the merger.
I. The concentration-profits hypothesis, 294. — II. Industry definition, measure of concentration, and selection of sample, 297. — III. Character and limitations of profit data, 305. — IV. Calculation of accounting profit rates, 310. — V. Association of industry profit rates and concentration, 311. — VI. Association of firm profit rates and industry concentration, 317. — VII. Association of profit rates with other determinants, 321. — VIII. Summary, 323. Copyright, 1951, by the President and Fellows of Harvard College.
The Treaty of Rome of 1957, creating the European Economic Community and its institutions—the Council of Ministers, the European Parliament, the Court of Justice, and the European Commission (EC)—included articles condemning anticompetitive agreements among competitors and abus-es of a dominant position. Merger control was not specifically mentioned in those articles. The need for merger control at the Community level was recognized in the early 1970s—coincidentally, at about the time that Germany amended its antitrust law to give the Bundeskartellamt merger control authority and shortly before the U.S. Congress enacted the Hart-Scott-Rodino Act requir-ing premerger notification—as the EC's attempts to apply both Articles 81 and 82 to mergers illu-minated its shortcomings. The EC did not obtain merger control authority, however, until 1989, when—stamped with the "EC-92" label—its enactment was viewed as one of many measures necessary to facilitate the development of a single, integrated—or "common"—European market. EU merger control was intended to provide a "level playing field" in a "one-stop shop" for the examination of mergers with significant cross-border effects. Reflecting the reluctance of the Member States to cede such authority to the Commission and skepticism of the Commission's ability to act in a timely manner, the Council of Ministers, in enacting the Merger Regulation, placed jurisdictional and procedural restrictions on the Commission's authority. The former limits the scope of the EC's merger control authority vis-à-vis the Member States and the latter subjects the Commission to certain, non-waivable decision deadlines. Amendments to the Merger Regulation, adopted in 2003, and effec-tive since May 1, 2004, make evolutionary changes that preserve these distinctive elements of EU merger control. The Commission, coincidentally, also adopted consequential administrative and organizational changes. This article reflects the state of the Merger Regulation and implementing and interpretive instruments as of November 2004. The EC Merger Regulation reflects legal structures and policy decisions that differ in important respects from those with which most American practitioners are familiar under U.S. law. Some of those differences—especially the division of jurisdiction between the Commission and the Member States and the procedural deadlines—have practical consequences that can be mag-nified when a merger is also subject to review by U.S. and other authorities. Differences in pro-cedure under the EC Merger Regulation and the U.S. process under the Hart-Scott-Rodino Act (HSR) are noted at relevant points throughout this Guide.
We develop a model of endogenous mergers to study their dynamic process. Firms choose whether, when, and with whom to merge. Two necessary conditions are identified for mergers to occur: firm heterogeneity and negative demand shocks. We show that mergers are strategic complements and therefore tend to occur in waves. Moreover, some mergers occur for strategic reasons in order to precipitate further mergers.
We analyse the effects of investment decisions and firms' internal organisation on the efficiency and stability of horizontal mergers. In our framework efficiency gains are endogenous and there might be internal conflict within merged firms. We show that, both with and without conflict, stable mergers often do not generate efficiency gains. In the case of internal conflict, mergers may even lead to efficiency losses. Our welfare results suggest that antitrust authorities may approve welfare-reducing mergers (type II error) and block welfare-enhancing mergers (type I error) if they assume that potential efficiency gains will always be realised. In addition, the paper offers a possible explanation for merger failures.
Several authors have studied the impact of a marginal cost variation in the Cournot model on consumers' surplus, firms' profits and social welfare. We unify and extend the results when all marginal costs change simultaneously. Hence, we bring together two strands of literature, respectively, on mean-preserving and subgroup common shocks. The effect of any shock is decomposed into two parts: an average impact (AI) and a heterogeneity effect (HE). The former improves welfare if the inverse demand function is concave enough and the market is concentrated enough, the latter when the diffusion of the shock is negatively correlated with the market share distribution. Finally, we apply our decomposition to various special cases.
We consider the impact of horizontal mergers in the presence of free entry and exit. In contrast to much of the previous literature on mergers, our model yields predictions that seem intuitively reasonable: with only moderate cost synergies mergers of a small number of industry participants are beneficial (even under quantity competition), there is no “free rider problem” in that insiders always benefit more than outsiders, and quantity-setting and price-setting games yield similar predictions about profitability. We also derive two welfare results that hold under quantity competition with homogeneous goods: If the initial, no-merger equilibrium is symmetric, then with free entry, (1) a horizontal merger has no impact on the equilibrium price and (2) all privately beneficial mergers are socially beneficial.
This paper models a sequential merger formation game with endogenous efficiency gains in which every merger has to be submitted for approval to the Antitrust Authority (AA). Two different types of AA are studied: first, a myopic AA, which judges a given merger without considering that subsequent mergers may occur; and, second, a forward looking AA, which anticipates the ultimate market structure a given merger will lead to. By contrasting the decisions of these two types of AA, merger policy implications can be drawn. In particular, the efficiency offence argument does not find any justification under a forward looking AA.
This paper develops a dynamic industry model with heterogeneous firms to analyze the intra‐industry effects of international trade. The model shows how the exposure to trade will induce only the more productive firms to enter the export market (while some less productive firms continue to produce only for the domestic market) and will simultaneously force the least productive firms to exit. It then shows how further increases in the industry's exposure to trade lead to additional inter‐firm reallocations towards more productive firms. The paper also shows how the aggregate industry productivity growth generated by the reallocations contributes to a welfare gain, thus highlighting a benefit from trade that has not been examined theoretically before. The paper adapts Hopenhayn's (1992a) dynamic industry model to monopolistic competition in a general equilibrium setting. In so doing, the paper provides an extension of Krugman's (1980) trade model that incorporates firm level productivity differences. Firms with different productivity levels coexist in an industry because each firm faces initial uncertainty concerning its productivity before making an irreversible investment to enter the industry. Entry into the export market is also costly, but the firm's decision to export occurs after it gains knowledge of its productivity.
Capitalism, Socialism and Democracy remains one of the greatest works of social theory written in the twentieth Century. Schumpeter's contention that the seeds of capitalism's decline were internal, and his equal and opposite hostility to centralist socialism have perplexed, engaged and infuriated readers since the book's first publication in 1943. By refusing to become an advocate for either position, Schumpeter was able both to make his own great and original contribution and to clear the way for a more balanced consideration of the most important social movements of his and our time.
We construct a model where firms compete in both political and economic markets. In political markets, firms compete for influence over government transfer policy (rents). This activity can be beneficial for the firm, but is purely wasteful from the point of view of society because resources are utilized to achieve a redistribution of income. In the economic market, firms compete for market share through cost reducing technological innovation. Market structure plays an important role in this economy because competition drives firms to invest more in innovation resulting in higher growth. Rent-seeking affects economic growth in two important ways. It diverts resources away from innovation and it affects the number of firms that are supported in equilibrium. The former has a negative effect on growth while the latter effect is ambiguous, depending on whether rent seeking induces entry or exit. This market structure effect depends on a combination of political and economic factors that the theory highlights.
Merger control authorities may approve a merger based on a so-called 'efficiency defence'. An important aspect in clearing mergers is that the efficiencies need to be merger-specific. Joint ventures, and in particular research joint ventures (RJVs), may achieve comparable efficiencies possibly without the anti-competitive (market power) effects of mergers. We present evidence for the semiconductor industry that RJVs indeed represent viable alternatives to mergers. We empirically account for the endogenous formation of mergers and RJVs.
An anticompetitive horizontal merger creats an opportunity for entry, which might deter or counteract the competitive effects of concern. This paper analyzes mergers in randomly generated Cournot and Bertrand Industries to ascertain the incremental effect of the mergers on the profitability of entry, and determine the net effects on prices welfare of the mergers followd by entry.
Three years ago, the Antitrust Division and the Federal Trade Commission revised their Horizontal Merger Guidelines to articulate in greater detail how they would treat claims of efficiencies associated with horizontal mergers: claims that are frequently made, as for instance in the recently proposed merger between Heinz and Beech-Nut in the market for baby food. While these revisions to the Guidelines have a solid economic basis, they leave open many questions, both in theory and in practice. In this essay, we evaluate some aspects of the treatment of efficiencies, based on three years of enforcement experience under the revised Guidelines, including several litigated mergers, and based on economic principles drawn from oligopoly theory regarding cost savings, competition, and consumer welfare.
This paper analyzes the effects of mergers around the world over the past 15 years. We utilize a large panel of data on mergers to test several hypotheses about mergers. The effects of the mergers are examined by comparing the performance of the merging firms with control groups of nonmerging firms. The comparisons are made on profitability and sales. The results show that mergers on average do result in significant increases in profits, but reduce the sales of the merging firms. Interestingly, these post merger patterns look similar across countries. We also did not find dramatic differences between mergers in the manufacturing and the service sectors, and between domestic and cross-border mergers. Conglomerate mergers decrease sales more than horizontal mergers. By separating mergers into those that increase profits and those that reduce them and by then examining the patterns of sales changes following the mergers, we determine the effects of mergers on efficiency and market power. Our results suggest that those mergers that decrease profits and efficiency account for a large proportion. However, we can also identify mergers that increase profits by either increasing market power or by increasing efficiency. The first conclusion seems to be a more likely explanation for large companies, whereas the latter is likely to be true for small firms.
We analyze the effects of bilateral tariff reductions on the profitability of cost-reducing horizontal mergers. Given Cournot competition in a two-country world, for any positive tariff below a certain threshold, marginal trade liberalization is shown to encourage only those domestic mergers with sufficiently large cost-savings and to discourage the rest. For tariffs close to, but smaller than, the prohibitive tariff, however, marginal trade liberalization necessarily encourages all domestic mergers. Moreover, we show that for a given level of cost-savings, the impact of marginal trade liberalization may not reliably predict that of nonmarginal liberalization.
Although at high tariffs, domestic mergers are shown to be unambiguously more profitable than cross-border mergers, near free trade, mergers which yield the most cost-savings become the most profitable. Thus, when comparing domestic and cross-border mergers, trade liberalization encourages the type which yields the most cost-savings.
A two-country model of oligopoly in general equilibrium is used to show how changes in market structure accompany the process
of trade and capital-market liberalization. The model predicts that bilateral mergers in which low-cost firms buy out higher-cost
foreign rivals are profitable under Cournot competition. As a result, trade liberalization can trigger international merger
waves, in the process encouraging countries to specialize and trade more in accordance with comparative advantage. With symmetric
countries, welfare is likely to rise, though the distribution of income always shifts towards profits.
This paper reviews research that uses longitudinal microdata to document productivity movements and to examine factors behind productivity growth. The research explores the dispersion of productivity across firms and establishments, the persistence of productivity differentials, the consequences of entry and exit, and the contribution of resource reallocation across firms to aggregate productivity growth. The research also reveals important factors correlated with productivity growth, such as managerial ability, technology use, human capital, and regulation. The more advanced literature in the field has begun to address the more difficult questions of the causality between these factors and productivity growth.
We investigate the nature of selection and productivity growth in industries where we observe producer-level quantities and prices separately. We show there are important differences between revenue and physical productivity. Because physical productivity is inversely correlated with price while revenue productivity is positively correlated with price, previous work linking (revenue- based) productivity to survival confounded the separate and opposing effects of technical efficiency and demand on survival, understating the true impacts of both. Further, we find that young producers charge lower prices than incumbents. Thus the literature understates new producers' productivity advantages and entry's contribution to aggregate productivity growth. (JEL D24, L11, L25)
The effect on national welfare of uneven technical progress and eli mination of a firm is analyzed under the existence of a Cournot oligopolistic sector. An increase in the share of an inefficient firm, owing to its innovations, results in a shift of production from more efficient firms to the inefficient firm, causing a less efficie nt allocation of production. It may decrease welfare even though the innovation itself is beneficial. Conversely, policies keeping ineffic ient firms from innovations or eliminating them may increase welfare, though they make the market structure more oligopolistic. Copyright 1988 by Royal Economic Society.
Can undesirable (from a global perspective) outcomes be prevented by an international agreement establishing common rules for merger approval? Or must a global merger authority be established, and if so by what rules should it operate? Here we investigate the economic issues involved in answering these questions and illustrate them through a simple model intended to highlight the international links involved. Section 2 begins by considering the circumstances under which a merger will raise both the joint profits of the participating firms and global welfare. These conditions are first investigated in the context of a closed economy. Section 3 then looks at the implications of trade liberalisation on the profitability of mergers, finding that liberalisation is likely to generate merger activity involving firms in the previously protected market. Complete liberalisation achieves an integrated world market, where the conditions for profitable and welfare improving mergers are as in the closed market. But whether mergers that meet both these conditions will be permitted to proceed depends on how the costs and benefits from the merger are distributed internationally. Section 4 therefore considers the welfare implications of mergers between firms in the same country (national mergers) and in different countries (international mergers). Potential conflicts between national welfare and world welfare as criteria for merger approval become apparent, and the considerable difficulties involved in avoiding such conflicts are highlighted. The final section presents a summary and conclusions.
In a paper that has become a standard reference in the structure-conductperformance approach to industrial economics, Cowling and Waterson (1976) developed a theoretical rationale for expecting industry profitability to be positively correlated with the level of concentration. Their model, based on a simple algebraic description of oligopoly behaviour, has been interpreted as providing a justification for the common empirical practice of cross-industry regression analysis of price-cost margins in terms of concentration levels. In the present paper we show that, on further examination, this model implies a joint determination of margins and concentration. This provides some interesting comparative static results of relevance to inter-industry differences in concentration levels. Equally, however, it leads to various (cautionary) insights concerning the meaning of price-cost margin versus concentration regressions.
"Returning to the contention that convex costs provide a resolution to the merger paradox, we show that for reasonable degrees of convexity, the minimum market share needed for merger to be profitable remains close to that associated with linear costs. Moreover, convex costs do not eliminate the free rider problem identified as part of the merger paradox. Finally, we retain convex costs while modeling a firm-by-firm sequential merger process, showing that the paradox constrains a larger share of potential mergers. These findings help reduce the relevance of convex costs as a resolution to the merger paradox." ("JEL" L12, L13) Copyright 2006 Western Economic Association International.
According to the advocates of a "Generalized Darwinism" (GD), the three core Darwinian principles of variation, selection and retention (or inheritance) can be used as a general framework for the development of theories explaining evolutionary processes in the socioeconomic domain. Even though these are originally biological terms, GD argues that they can be re-defined in such a way as to abstract from biological particulars. We argue that this approach does not only risk to misguide positive theory development, but that it may also impede the construction of a coherent evolutionary approach to "policy implications". This is shown with respect to the positive, instrumental and normative theories such an approach is supposed to be based upon.
Merged firms are typically rather complex organizations. Accordingly, merger has a more profound effect on the structure of a market than simply reducing the number of competitors. We show that this may render horizontal mergers profitable and welfare-improving even if costs are linear. The driving force behind these results, which help to reconcile theory with various empirical findings, is the assumption that information about output decisions flows more freely within a merged firm. This induces a commitment advantage for the merged firm. Copyright (c) The London School of Economics and Political Science 2004.
Reallocation, firm turnover, and efficiency: Selection on productivity or profitability? Mergers and the evolution of industry concentration: Results from the dominant-firm model
- L Foster
- J Haltiwanger
- Syverson
- G Rgowrisankaran
- T J Holmes
Foster L., Haltiwanger J., and Syverson C. Reallocation, firm turnover, and efficiency: Selection on productivity or profitability? American Economic Review, 98(1):394–425, 2008. 17 rGowrisankaran G. and Holmes T. J. Mergers and the evolution of industry concentration: Results from the dominant-firm model. The RAND Journal of Economics, 35(3):561–582, 2004
Horizontal merger guidelines
EC. Horizontal merger guidelines. Technical report, European Commission, Competition Directorate,
2004.