Most mergers in industries with only a handful of competitors are anticompetitive, so why don’t we block them? The fix is to use a structural presumption to lower the burden for regulators.
Declining merger enforcement over the past 25 years has harmed consumers, workers, nondominant businesses, and the U.S. economy generally. In response, there has been an outpouring of proposals for reform, but in order to ensure that reforms are well targeted we must understand what’s gone wrong. For what types of mergers has enforcement been weakest? Research reveals that the enforcement gap is largest for mergers that result in markets with three to six remaining firms. Fortunately, however, there is a straightforward and effective solution: a structural presumption against mergers in industries with only a handful of competitors.
The merger enforcement gap
A well-designed merger enforcement policy should focus on mergers with the greatest likelihood of anticompetitive outcomes. That, however, has not been the case in the U.S. Rather, there has been a large, systematic, and indeed growing difference between the focus of agency enforcement and the locus of anticompetitive outcomes, as we can readily show.
Data on agency enforcement patterns come from a series of reports by the Federal Trade Commission on its merger investigations and “enforcement actions,” a term including abandonments and remedies as well as litigation. For all 1,218 investigations between 1996 and 2011 when the data series ends, the FTC took some kind of enforcement action in 78.6 percent of cases. Quite sensibly, as shown in column B of the table below, this rate rises with market concentration, from modest levels when firms are more numerous but reaching nearly 100 percent for the highest reported category of concentration. Concentration is here measured by the number of remaining significant competitors in the market, but similar results hold using HHI.
Evidence on the second relationship, that between concentration and competitive outcomes, comes from retrospective analyses of the effects of actual mergers. My meta-analysis of some 60 published merger retrospectives covered more than 40 different “close call” mergers, those investigated but then cleared by the agency. That analysis found that, overall, 83 percent of mergers proved to be anticompetitive in the sense of resulting in significant price increases, after controlling for other factors.
Again, breaking this down according to market concentration, column C reveals that all of these carefully studied mergers-to-monopoly resulted in higher prices, as did all “three-to-two” mergers in the data, and in fact all those resulting in four or five significant competitors. Significant percentages of those with six and even seven remaining competitors also appear to be anticompetitive.
Calculating the Merger Enforcement Gap
|Number of Remaining Competitors||Percent enforced||Percent anticompetitive||Enforcement Gap|
* No data points. Gap by interpolation.
The arithmetic difference between these two series can be interpreted as the enforcement gap since if most mergers at a given concentration level are anticompetitive but do not trigger any enforcement action, that points to systematic underenforcement. As shown in the table, there is no significant gap in enforcement when concentration is quite high and firm numbers very small. Most mergers to monopoly or duopoly are appropriately subject to enforcement. But the enforcement rate declines fairly sharply thereafter, even though the frequency of anticompetitive outcomes remains very high.
For mergers resulting in four firms, for example, the enforcement rate falls to 60 percent and, for five firms, it is less than 40 percent, despite the fact that in this range the reported frequency of anticompetitive outcomes remains very high. Accordingly, the enforcement gap in this range rises to 36 percent and then 65 percent, indicating substantial underenforcement. For more than six remaining firms, the enforcement gap narrows again as mergers become less likely to have anticompetitive effects and enforcement activity diminishes in tandem.
While these data have their limitations—too few observations in some categories, time frames that do not perfectly match—they nonetheless highlight the type of mergers for which enforcement seems to have been especially deficient.
Closing the enforcement gap
These results naturally raise the question of why enforcement has been systematically weak in the range of three to six remaining firms. While there may be other factors, it is well understood that merger challenges in this range are especially difficult for the agencies to bring when the key competitive concern is the likelihood of post-merger coordination among the remaining firms. The difficulty derives from the fact that there is, generally speaking, no single number of competitors where coordination suddenly becomes distinctly likely. Rather, the likelihood depends on several factors, so that any single merger may simply increase the probability of an anticompetitive outcome.
As a result, a court that insists on a high degree of assurance that a particular challenged merger is uniquely responsible for tipping the balance is not likely to rule against the merger, and the agencies likely become more cautious about even bringing such cases. Corroborating this, FTC staff analysis of its own case-bringing has shown that coordination was alleged in more than half of all merger cases in 1989-1990, but that fraction fell steadily to less than 15 percent after 2005.
How can we fix this? Since the problem is the often unrealistic burden of proof, the most straightforward and effective solution is to reconsider what is sufficient proof in these circumstances. As it happens, both economics and the law provide strong justification for reliance on the use of concentration as a practical and observable predictor of anticompetitive outcomes—the so-called structural presumption.
Evidence from merger retrospectives reported above provides empirical support for a sliding-scale presumption. At the extreme, since virtually all mergers resulting in monopoly, duopoly, and perhaps triopoly prove to be anticompetitive, a very strong presumption against such mergers would seem warranted. Given the high costs and low probability of identifying those rare exceptions, “very strong” might appropriately mean truly irrebuttable.
Next, for mergers resulting in four or five remaining firms, a somewhat less strong presumption seems appropriate since there are more instances where mergers are not anticompetitive. Here the presumption should take the form of shifting of the burden of proof to the merging parties to demonstrate a pro-competitive outcome, or at least the absence of competitive concern. Finally, for mergers involving yet more numerous firms—six or more— judging from the data in the table, the usual approach where the agency bears the burden of proof seems most appropriate.
Dovetailing perfectly with this empirical justification, the Supreme Court has addressed the difficulties of proof in these same circumstances. In its 1963 Philadelphia National Bank decision, the Court noted that the competitive effect of a merger “is not the kind of question that is susceptible to a ready and precise answer in most cases” and instructed lower courts to “simplify the test of illegality…[by] dispensing, in certain cases, with elaborate proof of market structure, market behavior, or probable anticompetitive effects…”
How did the Court suggest simplifying that task? It stated that any “merger which produces a firm controlling an undue percentage share of the relevant market, and results in a significant increase in the concentration of firms in that market, is so inherently likely to lessen competition substantially that it must be enjoined in the absence of evidence clearly showing that the merger is not likely to have such anticompetitive effects.”
Remarkably, this standard has never truly been implemented. While the 2010 and earlier Merger Guidelines provide for a preliminary judgment about the competitive effects of a merger based on concentration, this has never served as a true presumption. Going forward, merger enforcement by the agencies and the courts would be well served by embracing the Supreme Court opinion in all its particulars. That would relieve the agencies of the pointless task of proving the obvious in cases of mergers to monopoly and duopoly, and of attempting to prove the often unprovable in mergers resulting in four or five firms. This would close the enforcement gap, conserve agency resources, and provide bright line guidance to companies and the courts, all without making errors more often than at present. Few policy reforms promise such manifold benefits.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.