Mergers, Acquisitions, & Anti-Competitive Business Practices

Paul L. Schumann, Ph.D.

2003 by Paul L. Schumann. All rights reserved.

Background (Review)
Competitive free market Capitalism is

ethical because it:

Achieves utilitarian goal: maximizes net social benefits Protects rights: the liberty and property rights of buyer and seller Is fair: produces a fair distribution of benefits and costs (under Capitalist definition of Distributive Justice)

Background (Review)
However, government regulation might be

justified in order to:

Correct externalities Protect other rights Ensure fairness Support caring

But the advantages of free market

Capitalism depend on competition

Perfect Competition
Criteria include: Numerous small buyers & sellers Freedom of buyers & sellers to enter or leave the market Perfect information of all relevant facts about the product or service Result: Buyers & sellers are protected by

competition from exploiting each other

Threats to Competition
Monopoly

Oligopoly
Anti-competitive practices

3 Major US Anti-Trust Laws

Sherman Anti-Trust Act (1890)

Clayton Act (1914)

Federal Trade Commission Act (1914)

Sherman Anti-Trust Act (1890)

Forbids: restraints of trade, monopolization,

attempts to monopolize, and conspiracies to monopolize

Example of restraints of trade: price fixing

Criminal statute Violations can be felonies

Fines: corporations & individuals Prison: individuals

Civil lawsuits: treble damages

Clayton Act (1914)

Forbids specific anti-competitive practices: Mergers that tend to create a monopoly Interlocking Boards of Directors among competitors Exclusive dealing arrangements Tying arrangements Price discrimination (goods only, not services) Civil statute: no criminal penalties

FTC Act (1914)

Forbids: Unfair methods of competition Unfair or deceptive acts or practices that affect commerce

Civil statute: Remedies: cease and desist orders

US Anti-Trust Enforcement
1. US Department of Justice (DOJ)

Anti-Trust Division:
Headed by the Assistant Attorney General for Anti-Trust Criminal actions under Sherman Act Civil actions under Sherman or Clayton Acts www.usdoj.gov/atr/

US Anti-Trust Enforcement
2. Federal Trade Commission (FTC): Civil actions under Sherman, Clayton, or FTC Acts Headed by 5 Commissioners:
Staggered 7-year terms of office Appointed by President of US Advice & consent of US Senate Maximum of 3 from one political party

www.ftc.gov/

US Anti-Trust Enforcement
3. Enforcement by state governments Enforce state anti-trust laws Enforce federal anti-trust laws by filing antitrust lawsuits

US Anti-Trust Enforcement
4. Private party civil lawsuits: Party harmed by violation of anti-trust laws can sue in court Injunctions Treble damages

Anti-Trust Case Outcomes

Drop the case: insufficient evidence of

violation of the law Consent decree:

Negotiated settlement between company and government No admission of guilt

Court decision

Anti-Trust Remedies
Monetary damages Injunctions: cease & desist orders Conduct remedies: Limits on future actions Continuing court oversight may be required Structural remedies: Change structure of situation to prevent future violations Reduces the need for continuing court oversight Sherman Act criminal cases: fines & prison

Threats to Competition
Monopoly

Oligopoly
Anti-competitive practices

Monopoly
2 Key Characteristics: Only one seller: 100% market share Extremely high barriers to entry:
High capitalization costs
Example: electric power?

Patents
Example: pharmaceutical drugs

Example: Does Microsoft have a monopoly

with Windows?

Monopoly Economic Effects

Control over
Price

prices:
Supply = Marginal Cost

Pm Pc

Marginal Revenue Qm Qc

Demand Quantity

Higher prices than would occur with competition Higher profits for the monopolist

Monopoly Moral Effects

Violates
Price

utilitarianism
Supply = Marginal Cost

Pm Pc

Deadweight loss to society from higher prices Inefficiency?

Violates rights:
Marginal Revenue Qm Qc Demand Quantity

restricted choices Violates justice: unfair to consumers

Monopoly Regulation
Natural monopoly: regulate prices Example: electric power? Government-granted monopoly through

patents: limit length of patent protection

Example: pharmaceutical drugs

Earned monopoly: regulate ability to use

earned monopoly power to extend monopoly to new markets

Example: Microsoft?

Threats to Competition
Monopoly

Oligopoly
Anti-competitive practices

Oligopoly
2 Key Characteristics: Small number of sellers dominate the market High barriers to entry Result: Threat of collusion among sellers to act in unison: act as monopoly instead of competitors

Government regulation: Prevent collusion

Mergers
Mergers can generate anti-trust concerns

Mergers are thus subject to government

regulation 3 types of mergers:

Horizontal merger Vertical integration Conglomerate merger

Horizontal Merger
Competitors merge Example: merger of Chevron & Texaco Anti-trust concern: might directly reduce

competition significantly. To decide:

Define relevant product market Define relevant geographic market Examine effect of merger on market shares Analyze barriers to entry

Regulate merger terms & conditions

Vertical Integration
Merger up or down the chain of production and

distribution
Example: Merger of Time-Warner (content) & AOL (distribution)

Anti-trust concern: might harm competition

significantly
Why? Possibility of cut-off supply to the competitor. Issue: Are there alternative sources of supply that are economically viable?

Regulate merger terms & conditions

Conglomerate Merger
Totally unrelated companies merge Example: US Steel and Marathon Oil Rationale: diversificationdont put all

your eggs in one basket Anti-trust concern: deep pockets / internal cross-subsidization / may facilitate predatory pricing Regulate merger terms & conditions

Threats to Competition
Monopoly

Oligopoly
Anti-competitive practices

Anti-Competitive Practices
1. Price fixing

2. Manipulation of supply
3. Exclusive dealing arrangements

4. Tying arrangements
5. Retail price maintenance 6. Price discrimination

1. Price Fixing
Conspiracy by competitors to collude to

raise prices
Example: Retail gasoline? Effects:
Reduced competition based on price Higher prices Higher profits for the conspirators

Generally illegal (per se vs. rule of reason)

2. Manipulation of Supply
Conspiracy by competitors to collude to

reduce the supply of the product or service

Examples:
Market allocation conspiracies: illegal OPEC

Effects:
Higher prices Higher profits for the conspirators

3. Exclusive Dealing Arrangements

Seller agrees to sell to a buyer on the condition

that the buyer agrees not to buy from other sellers

Examples:
A gasoline refinery that sells to independent gas stations on the condition they agree to buy exclusively from the refinery McDonalds? Microsoft pricing of Windows to computer manufacturers?

Achieves the effect of vertical integration without an actual merger Effect: reduced competition Illegal if it substantially reduces competition

4. Tying Arrangements
Seller agrees to sell one item to a buyer on

the condition that the buyer also buys another item

Example: Windows & Internet Explorer (IE)? Effect: reduced competition Illegal if:
1. 2 distinct products, and 2. Seller has market power for one of the products

5. Retail Price Maintenance

Manufacturer agrees to sell to retailer on the

condition that the retailer charges the retail price specified by the manufacturer
Example: TV manufacturer will only sell to a retailer if the retailer charges the retail price specified by the TV manufacturer Effect: reduced price competition among retailers Illegal: retail price maintenance agreements Legal: refusals to deal

6. Price Discrimination
Seller charges different prices to different

buyers for identical goods

Example: Wal-Mart opens a store in a town and charges lower prices than it charges in other towns for the same merchandise? Effect: may reduce competition Illegal for goods, not illegal for services
Defenses: (1) cost or (2) meet competition

Price Discrimination by Airlines

Example: MSP to ORD round trip fares: $ 284 (21 day advance purchase, Saturday stay) $ 882 (no advance purchase, no Saturday stay) Not illegal (transport is a service) Airlines say price discrimination necessary Example: city Y to city Z costs airline $150
2 customers: person A will pay up to $50, person B will pay up to $100 No price discrimination ($75), no flight

Bribery
Bribery is another issue that raises anti-

competitive concerns
Example: A company that wins a sale by paying a bribe to the purchasing agent of the buyer harms:
The buyer: doesnt get the best deal The competitor: doesnt get the sale theyve earned

Bribery, Extortion, & Gifts

Bribe: I bribe you when I give you

something of value in order to get you to do something that violates your moral duties
Example: bribe a police officer to avoid a traffic ticket that was deserved Example: bribe a professor to get a better grade than was earned Example: bribe a purchasing agent to get a sale that was not earned on the merits of the deal

Bribery, Extortion, & Gifts

Extortion: I extort you when I coerce you to

give me something of value by making an illegitimate threat against you

Example: pay me $1000 per month or else Ill burn down your restaurant Example: pay me $500 or else Ill give you an F grade in the class even though youve earned a better grade than F Example: purchasing agent extorts seller

Bribery, Extortion, & Gifts

Gift: I give you a gift when I give you

something of value without expecting anything in return from you that would violate your moral duties, and you have not illegitimately threatened me
No strings attached Example: a professor brings candy for his or her students on Halloween

Questionable Payments
Example (hypothetical!): The College Technology

Committee spends 2 weeks in Hawaii paid for by Dell, at a total cost to Dell of $30,000; the Committee later decides all Business students must buy laptops from Dell.
Has Dell given a gift to the Committee members? Or has Dell bribed the Committee members? Or has the Committee extorted Dell?

Questionable Payments
Example (hypothetical!): Dell takes the

College Technology Committee to lunch at Maggies, at a total cost to Dell of $60; the Committee later decides all Business students must buy laptops from Dell.
Has Dell given a gift to the Committee members? Or has Dell bribed the Committee members? Or has the Committee extorted Dell?

Bribe vs. Gift Guidelines

1. Value: Is the value substantial enough that

its likely to influence the recipients decisions? 2. Purpose: Is the purpose to influence the recipients decisions? 3. Circumstances: Is it given openly? 4. Recipients Position: Is the recipient in a position to influence dealings with the giver?

Bribe vs. Gift Guidelines

5. Accepted Practice: Is it an open and well-

known practice? 6. Company Policy: Does the company have a policy that forbids acceptance? 7. Law: Is there a law that forbids acceptance?

Foreign Corrupt Practices Act (1977)

Forbids: payments to higher-level foreign

government officials for the purpose of gaining business

Extensive accounting requirements to uncover bribery Corporate fines Individuals: fines & prison

Does not forbid grease or facilitating

payments to low-level foreign government employees to do routine (not illegal) functions