Steven C. Salop argues that Section 7 of the Clayton Act prohibits mergers in which the acquiring firm’s unilateral incentives and business strategy are likely to lessen market competition.

The text of Section 7 of the Clayton Act prohibits mergers and acquisitions “where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.” Competition may be lessened when the acquisition will create or increase incentives of a substantial risk of higher prices and reduced output in a “downstream” market that harms consumers, or lower prices and reduced output in an “upstream” market that harms the relevant workers or other counterparties.

The plain language of the prohibition includes acquisitions by firms not previously competing in the relevant market that lack the market constraints on its incentives to raise prices that previously constrained the seller firms. For example, in his concurrence in the Ovation merger case, former FTC Commissioner J Thomas Rosch suggested that the selling firm (Merck) had unexercised monopoly power for its product, Indocin, yet was deterred from raising the price by reputational constraints. By contrast, the acquirer, Ovation, did not sell other products, so it faced no similar reputational constraints. This is not mere speculation. Indeed, after acquiring Indocin, Ovation substantially raised the price by roughly 1,300 percent.

The 2023 draft Merger Guidelines applies this approach, raising concerns with acquisitions that would “dampen the acquired firm’s incentive or ability to compete due to the structure of the acquisition or the acquirer.” This concern appears targeted at private equity acquisitions and leveraged buyouts (LBOs), in which the structure of the transaction or the acquirer affects its incentives to compete. Former FTC Commissioner Rohit Chopra earlier argued that private equity firms have an interest in setting higher prices, which amounts to a lessening of competition with other rivals in the relevant market. The impact on product quality and competition after private equity acquisitions and LBOs also has been a source of recent concerns, particularly in the health care sector (here and here), where exploitation of regulatory loopholes is a concern. Such quality reductions involve reduced competition and give rivals the ability and incentive to compete less intensely.

Flawed criticisms

It has been suggested that Section 7 should not apply to this effect. One critic suggested that the selling firm in Ovation (Merck) could have adopted the anticompetitive strategy itself absent the merger, so the harm is not “merger-specific.”  Others have suggested that this anticompetitive effect does not involve the “competitive process.” However, these arguments are fundamentally flawed.

The conduct is merger-specific because the post-merger lessening of competition flows directly from the acquisition. The idea that it is “just” a management decision ignores the fact that the 1982 Merger Guidelines stressed that acquisitions are valued because they may lead to improved management. Moreover, in this case, the management seller firm lacked an incentive to raise price because of its market constraints that are part of the competitive process. The competitive process version of the criticism also misses the point because the increase in the price of the acquired product generally will lead to rival producers also raising their prices.

Antitrust agencies commonly analyze the acquirer’s business plan for likely anticompetitive tendencies and incentives. For example, suppose that the acquirer’s business plan in a highly concentrated market involves unilateral conduct that would not violate Section 1 but might improve the likelihood of successful tacit coordination. The plan might involve unilateral conduct such as: announcing price increases well in advance so rivals have time to respond; quickly responding to rivals’ price increases and decreases; or announcing at earnings calls that margins are too low. Such behavior by the acquired firm—absent the merger—would not violate the high bar of Section 1’s agreement requirement. Yet, those plans for the merger would be treated as reasons to block the merger. Indeed, a key function of merger law is to prevent a situation where legal tacit coordination is more likely to occur. Similarly, a business plan to raise prices would be treated as a “hot doc” to use at trial even though the selling firm would have been legally permitted to engage in this conduct.

There should be exceptions to a blanket rule applying Section 7 to all conduct which may raise prices. For example, suppose that the acquiring firm has a business plan to shift its capacity from producing widgets to gadgets, which would lead to higher prices of widgets and lower prices of gadgets. That merger typically would violate Section 7 because the gadget price reduction would be a non-cognizable out-of-market efficiency. But allowing this acquisition to proceed because of these inextricably linked efficiency benefits does not invalidate the concerns in scenarios discussed above where there are no consumer benefits in any market.

Of course, this door swings both ways. The Ovation theory similarly could be used as a possible justification for a merger. For example, a highly profitable multi-product firm could argue that its acquisition of a competing product from a single product firm would lead to lower prices, despite the reduction in competition, because of its increased reputational constraints. Or if a firm can provide credible evidence it would have incentives to become a “super maverick” that lowers prices after the merger, that rebuttal would be valid.

Regulatory evasion and bankruptcy risks

This approach to Section 7 might also be applied to concerns about mergers that permit avoidance of regulatory constraints, a concern in the 1982 Merger Guidelines that remains relevant even in today’s more deregulated economy. It has arisen in mergers where physician practices are acquired by hospitals because hospital-based services are reimbursed by Medicare at a higher price. The acquired firm can shift the actual services or simply their reported location to obtain higher prices. While this is a regulatory issue, the avoidance of the regulatory constraint is facilitated by the merger. For this reason, Section 7 applies even if claimed avoidance of regulation by a single firm would not be treated as an antitrust offense under Trinko and Nynex.

This approach to Section 7 might also be applied to bankruptcy risks. The 2023 draft Merger Guidelines states a concern “if the merger threatens to cause the exit of a current market participant, such as a leveraged buyout that puts the target firm at significant risk of failure.” If a multi-product firm fails, the losses of one division would be borne by the shareholders. But if an operating company managed and partially owned by a private equity investor fails, it can declare bankruptcy. Bankruptcies can lessen competition and harm counterparties in several markets.

Consider an LBO acquisition that raises a substantial risk of bankruptcy if there is a recession within a few years. That bankruptcy might lessen competition in several markets. For example, suppose that a retail acquisition finances the deal with large debt, sells the land under the stores and leases them back at a high rent, and distributes the proceeds to the private-equity owners and investors. Suppose it also distributes the excess funding in the pension plan. Suppose the plan recognizes that bankruptcy might occur if there is a recession in the next five years, but that it would not make the acquisition unprofitable since the pension plan would be offloaded to the federal government’s Pension Benefit Guaranty Corporation (PBGC), and the money owed to merchandise vendors that provided trade credit and the pension plans that purchased the debt would be forgiven. Union workers also might be coerced into accepting lower wage rates rather than risk the stores being closed.

This bankruptcy likely would lead to lower welfare for consumers, workers, vendors, as well as the taxpayers that finance the PBGA. Competition likely would be lessened since the post-bankruptcy company would be a weaker competitor with fewer stores and a damaged reputation. Unpaid vendors might be weaker or bankrupted, which could reduce competition in some wholesale markets as well.

This business strategy is not purely hypothetical. Consider Sun Capital’s bankruptcy of Friendly’s ice cream chain after it sold Friendly’s real estate and leased it back. Sun offloaded the pension liabilities to the PBGC, bought up the debt at highly discounted rates, and repurchased the company out of bankruptcy, free of the debts. The Sun CEO defended its behavior simply by saying, “We don’t make the rules,” a remark that Tony Soprano might have made.

These concerns are not new. Concerns about wealth expropriation from employees were raised during the wave of LBOs beginning in the 1980s. It was alleged that acquisitions harmed the workers with lower wage rates and reduced employment. For example, Andrei Shleifer and Larry Summers characterized LBOs as breaking the implicit contracts between the firm and its unionized employees by extracting the “rents” that were accruing to the unionized workers. David Neumark and Steven Sharpe applied this same idea to breach of trust and rent extraction from older workers.

When Safeway was sold in an LBO in 1986, the acquirers sold off stores to raise capital to pay off the debt it used to fund the purchase. The acquirers threatened unions that they would sell the stores to non-union firms that likely would sell assets if the unions would not accept deep pay cuts. Wage concessions were obtained in some areas, but other stores sold piecemeal. There were many layoffs and store closings. Workers re-employed by new ownership largely obtained lower wages. By contrast, the transaction was very profitable for the acquirers. One estimate reckoned the value of their investment rising from $200 million up to $800 million in four years. Thus, a business plan that involves substantial risk of bankruptcy and the associated probability of lessened competition in these markets might be held to violate Section 7.

While bankruptcies may be legal, mergers that facilitate bankruptcies can violate Section 7, as can regulatory evasion or other legal conduct. As noted above, while unilateral conduct that facilitates tacit coordination may be legal as beyond the reach of Section 1 of the Sherman Act, a merger that substantially increases the risk of such tacit coordination would not be legal under Section 7.  

Merger investigations

The antitrust enforcement agencies are beginning to focus on these risks in the acquirers’ business plans. The Agencies also should analyze the acquirer’s track record of previous acquisitions. Analysis of the acquiring firm’s track record is already common in merger investigations and litigation. For example, in the Microsoft/Activision merger litigation, Microsoft pointed to the fact that it had not withheld certain games from rivals. In the United Healthcare Group/Change merger litigation, United Healthcare Group argued that it had not misused competitors’ information in the past. Evidence of previous attempts to collude also is considered relevant in the 2010 Merger Guidelines and was noted in the Heinz/Beechnut merger litigation.

A firm’s track record may not be a reliable predictor. This is because the new acquisition changes its structure, which can change its incentives. For example, if a maverick firm that has disrupted or deterred tacit collusion acquires a rival, it will become larger and its incentives to coordinate with its competitors may increase. While a vertically integrated firm may not have misused sensitive competitive information gleaned from rivals in the past, its incentives to do so may increase if it becomes larger from a new acquisition. While a multi-product firm that owns a struggling division may fear that entering bankruptcy, exploiting and squandering its reputation for quality will harm its other divisions, incentives may change when the division is acquired by a standalone firm.

The Agencies also might begin to compare competing offers for a company even if there is no evidence of an immediate failing firm or failing division. While merger policy typically treats the but-for world as the no-merger status quo, it is not clear that this approach is required by Section 7. It is common today for firms considering a sale to hold an informal competition among potential acquirers. Where there are multiple offers, the Agencies can compare the competitive and associated welfare effects of the alternative proposals rather than treat the but-for world as no-merger. The highest price offer might not provide the best mix of competitive welfare effects for consumers, workers and other input suppliers. For example, if the highest bidder intends to implement an LBO with a significant risk of bankruptcy, whereas another bidder is a multi-product firm with no bankruptcy risk, that difference would be relevant. After all, once the acquisition is completed, firms have carte blanche to engage to “milk” their assets, coerce their workers or declare bankruptcy to escape their commitments, even if it lessens competition in the process.  

Author Note: Steven Salop is Professor of Economics and Law Emeritus, Georgetown University Law Center and Senior Consultant, Charles River Associates. The views expressed here are his own and may not be shared by colleagues or consulting clients.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.