Buckhorn Chair in Economics
June 2005
Mittal acquired International Steel Group. Procter & Gamble is buying Gillette for $58 billion. SBC is purchasing AT&T for $22 billion. Sears and Kmart are combining in an $11 billion deal. Verizon finally won a bidding war for MCI. Coors and Molson are merging. And this is just the tip of the iceberg of mergers and acquisitions that have characterized the last several years. The fundamental economic questions are:
• Do these and other mergers enhance economic welfare?
• What are the implications of the mergers for antitrust policy?
Mergers: Pros and Cons
There have been several periods of intense merger activity in the U.S. One was around 1900, then again in the late 1960s, 1980s, and 1990s. These periods of heavy merger activity have occurred when the economy was sustaining strong expansion and stock market performance. Between 1998 and 2000, during the stock market boom, more than 4,000 mergers were reported annually for antitrust review. In the early part of the current decade, that number dropped in half (Baker, 30-31). That decline in merger activity may well be a result of the weakened stock market in that period. However, even casual evidence suggests that the stronger stock market in 2003 and 2004 has caused a pick-up in merger activity, at least in terms of the mega-merger type deals.
Economists are by no means unified in their assessment of the benefits of mergers. One view is that large mergers have not enhanced efficiency. It is argued, for example, that a decade of mergers in the pharmaceutical industry has led to a decline in the development of new products rather than the anticipated growth in research and development. Likewise, consolidation in the airline industry has resulted in the largest carriers suffering the largest losses. The DaimlerChrysler combination has been controversial and has yielded neither the expected synergies nor the expected profits (Adams and Brock, 306-307).
Two other corporate deals that have thus far disappointed their proponents are the Hewlett-Packard and Compaq computer combination and America Online’s acquisition of Time Warner. After reasoning that H-P could compete in the whole spectrum of information technology from personal computers and printers to major corporate consulting projects, the firm’s stock became an underperformer and CEO Carli Fiorina lost her job. The America Online-Time Warner linkage has been widely regarded as a mistake, as well (Berman and La Tour).
In spite of the problems some high-profile mergers have incurred, mergers have their defenders on efficiency grounds. In a 2001 article, Andrade, Mitchell and Stafford of Harvard argued that when industry shocks occur, firms react to those shocks by restructuring, often through mergers (Andrade et al, 107).
Steel mergers such as the Mittal-International Steel Group (ISG) combination are a case study of the need for an industry to restructure in the face of the shocks of globalization trends. That merger, which will produce the world’s largest steel firm, combines not only the remnants of Cleveland’s former LTV steel (now ISG) but also Bethlehem, Inland, and Weirton steel, which were acquired earlier by the Mittal group. Mittal, which owns European mills as well, argues that the consolidated, globalized steel firm will be able to achieve increased efficiency through improved economies of scale. The efficiencies will come from access to lower-cost supplies of ore, coke and steel (Aston and Arndt).
When efficiencies are achieved, those arguing that mergers are beneficial can point to the conclusions of Andrade, Mitchell and Stafford that there is an improvement in operating margins of about 1 percent for the merged companies. Among shareholders, the principal beneficiaries of such mergers, according to the Harvard study, are the target firms’ shareholders who average a 24 percent return over a time window extending from 20 days before the merger to its closing date. Losers are acquiring firms’ stockholders; their return averages –3.8 percent over that same time period (Andrade et al, 109-110, 116).
Policy Implications
Given these mixed results from mergers and acquisitions, what is appropriate antitrust policy? Do we need more antitrust regulatory oversight, or will markets sort out the issue on their own?
Suspicion of concentrated power – political or economic – is deeply embedded in the American psyche and history. The United States Constitution has, in part, the philosophical goal of avoiding what the founding fathers considered the evil of concentration of power and the abuse that flows from it. Therefore, it is not surprising that the antitrust laws, including the Sherman Act of 1890 and the Clayton and Federal Trade Commission Acts of 1914, have as their goals dispersing economic power and preventing private organizations from monopolizing economic decision making. These laws were passed in response to the creation of trusts and concentration of economic power in the late 19th Century, which demonstrated that the competitive marketplace is not self-perpetuating and cannot be taken for granted (Adams and Brock, 299-300).
But do the antitrust laws achieve their stated goals? Again, economists differ in their interpretations. Brookings Institution Senior Fellows Robert Crandall and Clifford Winston analyzed a series of historic antitrust cases including Standard Oil (1911), American Tobacco (1911), Alcoa (1945), United Shoe Machinery (1954), and AT&T (1982 consent decree). They concluded that the protracted length of time taken to prosecute and try these cases means that even before a remedy is implemented, fundamental market conditions have changed. They also found that in many cases, the remedies imposed by the courts have negligible practical impact for the consumer. They concluded:
…any deterrent effect of the antitrust laws may be relatively small compared with the well demonstrated ability of competitive markets to deter anticompetitive monopolies, collusion, and mergers (Crandall and Winston, 21).
On the other hand, Jonathan Baker of American University’s Washington School of Law argued that the benefits of antitrust enforcement exceed the costs. He calculated the cost of antitrust enforcement by the U.S. Government at about $2 billion per year. He estimated the benefits of antitrust enforcement – just on the basis of collusion and price fixing prosecuted and/or deterred in recent years (the Archer Daniels Midland and Sotheby’s cases are used as illustrative examples) – may exceed $100 billion per year. Baker made that estimate by calculating the economic welfare benefits that accrue from deterring the exercise of market power. He concluded that our objective should be to sharpen the tools of antitrust enforcement to prevent abuses that come from monopoly power, such as excessive prices, collusion, and price fixing (Baker, 42-46).
Conclusion
There is no consensus on whether the current wave of merger activity will be a positive or negative contribution to economic welfare. The potential of improved service certainly exists. Customers may benefit from the Verizon-MCI and SBC-AT&T mergers, for example. The ISG-Mittal merger may bring efficiency gains to the steel industry which will benefit communities such as Cleveland and help stabilize their industrial base.
There is concern, however, that such mergers and consolidations raise efficiency and pricing issues. Will the combinations actually bring efficiencies or will Procter & Gamble-Gillette, Coors-Molson, and the steel and telecommunications mergers result in behemoth firms unable to discipline and streamline operations? Certainly the evidence from combinations such as Hewlett-Packard-Compaq and DaimlerChrysler is not encouraging, but the steel industry experience offers some hope.
When industries become more concentrated, there is a potential for exploitation of consumers through higher prices and deterioration in quality and service. Will the telecommunications consolidation result in enhanced, lower-cost service, or will it result in an arrogant price-gouging monopoly? Will global steel industry consolidation lead to higher-quality, lower-cost steel or to the exercise of monopoly pricing? Will airline consolidation lead to improved service and continued competitive pricing or to an industry more likely to exploit its passengers?
These are serious questions that economists and policy makers must debate. In the end, it can be argued that a vigilant, analytical, and thoughtful antitrust policy can both enhance the likelihood of efficiency and deter the worst abuses inherent in monopoly power.
Works Cited
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