Regulations for Approving Mergers
Since a merger combines two firms into one, it can reduce the extent of competition between firms. Therefore, when two U.S. firms announce a merger or acquisition where at least one of the firms is above a minimum size of sales, a threshold that moves up gradually over time, and was at $70.9 million in 2013, or certain other conditions are met, they are required under law to notify the U.S. Federal Trade Commission (FTC). The left-hand panel of Figure 11.2 (a) shows the number of mergers submitted for review to the FTC each year from 1999 to 2012. Mergers were very high in the late 1990s, diminished in the early 2000s, and then rebounded somewhat in a cyclical fashion. The right-hand panel of Figure 11.2 (b) shows the distribution of those mergers submitted for review in 2012 as measured by the size of the transaction. It is important to remember that this total leaves out many small mergers under $50 million, which only need to be reported in certain limited circumstances. About a quarter of all reported merger and acquisition transactions in 2012 exceeded $500 million, while about 11 percent exceeded $1 billion. In 2014, the FTC took action against mergers likely to stifle competition in markets worth 18.6 billion in sales.
The laws that give government the power to block certain mergers, and even in some cases to break up large firms into smaller ones, are called antitrust laws. Before a large merger happens, the antitrust regulators at the FTC and the U.S. Department of Justice can allow the merger, prohibit it, or allow it if certain conditions are met. One common condition is that the merger will be allowed if the firm agrees to sell off certain parts. For example, in 2006, Johnson & Johnson bought the Pfizer’s consumer health division, which included well-known brands like Listerine mouthwash and Sudafed cold medicine. As a condition of allowing the merger, Johnson & Johnson was required to sell off six brands to other firms, including Zantac® heartburn relief medication, Cortizone anti-itch cream, and Balmex diaper rash medication, to preserve a greater degree of competition in these markets.
The U.S. government approves most proposed mergers. In a market-oriented economy, firms have the freedom to make their own choices. Private firms generally have the freedom to
- expand or reduce production,
- set the price they choose,
- open new factories or sales facilities or close them,
- hire workers or to lay them off,
- start selling new products or stop selling existing ones.
If the owners want to acquire a firm or be acquired, or merge with another firm, this decision is just one of many that firms are free to make. In these conditions, the managers of private firms will sometimes make mistakes. They may close down a factory which, it later turns out, would have been profitable. They may start selling a product that ends up losing money. A merger between two companies can sometimes lead to a clash of corporate personalities that makes both firms worse off. Yet, the fundamental belief behind a market-oriented economy is that firms, not governments, are in the best position to know if their actions will lead to attracting more customers or producing more efficiently.
Indeed, government regulators agree that most mergers are beneficial to consumers. As the Federal Trade Commission noted on its website, as of November, 2013: “Most mergers actually benefit competition and consumers by allowing firms to operate more efficiently.” At the same time, the FTC recognizes, “Some [mergers] are likely to lessen competition. That, in turn, can lead to higher prices, reduced availability of goods or services, lower quality of products, and less innovation. Indeed, some mergers create a concentrated market, while others enable a single firm to raise prices.” The challenge for the antitrust regulators at the FTC and the U.S. Department of Justice is to figure out when a merger may hinder competition. This decision involves both numerical tools and some judgments that are difficult to quantify. The following Clear it Up helps explain how antitrust laws came about.
Clear It Up
What is U.S. antitrust law?
In the closing decades of the 1800s, many industries in the U.S. economy were dominated by a single firm that had most of the sales for the entire country. Supporters of these large firms argued that they could take advantage of economies of scale and careful planning to provide consumers with products at low prices. However, critics pointed out that when competition was reduced, these firms were free to charge more and make permanently higher profits, and that without the goading of competition, it was not clear that they were as efficient or innovative as they could be.
In many cases, these large firms were organized in the legal form of a trust, in which a group of formerly independent firms were consolidated together by mergers and purchases, and a group of trustees then ran the companies as if they were a single firm. Thus, when the U.S. government passed the Sherman Antitrust Act in 1890 to limit the power of these trusts, it was called an antitrust law. In an early demonstration of the law’s power, the U.S. Supreme Court in 1911 upheld the government’s right to break up Standard Oil, which had controlled about 90 percent of the country’s oil refining, into 34 independent firms, including Exxon, Mobil, Amoco, and Chevron. In 1914, the Clayton Antitrust Act outlawed mergers and acquisitions, where the outcome would be to substantially lessen competition in an industry, price discrimination, where different customers are charged different prices for the same product, and tied sales, where purchase of one product commits the buyer to purchase some other product. Also in 1914, the Federal Trade Commission (FTC) was created to define more specifically what competition was unfair. In 1950, the Celler-Kefauver Act extended the Clayton Act by restricting vertical and conglomerate mergers. In the twenty-first century, the FTC and the U.S. Department of Justice continue to enforce antitrust laws.
In this discussion of the Sherman Antitrust Act, the phrase price discrimination is used. Remember that monopolies, monopolistically competitive firms, and oligopolies are all, to some degree, price makers. The question is, why would these firms charge different prices to different customers? A firm can change its revenue by changing its price, based on price elasticity of demand. If price elasticity of demand is relatively elastic, revenue will increase if the firm lowers prices. Given fixed costs, this will cause profit to increase. If price elasticity of demand is relatively inelastic, revenue and profit will increase if the firm lowers prices. Thus, firms that are price makers can increase profits by charging groups of customers different prices, assuming those customers have difference price elasticities of demand. This assumes that the firm can prevent resale between the two or more groups of customers.
While under certain circumstances this behavior violates the Sherman Antitrust Act, in reality, firms have ways around these restrictions and regularly practice price discrimination. For example, the public transit authority in New York City uses peak and off-peak pricing for its trains. As you might imagine, peak hours occur during rush hour, when people are going into and leaving from work. Given that the demand for train service is probably highly inelastic when people have to get to work or have to get home from work, those fares are higher than the rest of the day and the weekend. Utilities, airlines, even movie theaters all practice price discrimination based on differences in price elasticity of demand across groups of customers.
